Brexit: tax consequences
The United Kingdom (UK) has decided to leave the EU following the referendum held on June 23, 2016. While this decision will affect a range of tax issues, EU law and, accordingly, EU tax rules will fully apply as long as the UK has not yet formally left the EU.
24 July 2018
The United Kingdom (UK) has decided to leave the EU following the referendum held on 23 June 2016. On 29 March 2017, the UK initiated the so-called art. 50 procedure governing the formal withdrawal from the EU, a two-year procedure. It heralds the UK’s formal withdrawal on 29 March 2019. This period can basically not be reduced or extended. Before that date, the UK and the EU will need to have reached mutual agreements on the architecture of the withdrawal, any EU-legal provisions that can possibly still be retained, and any transitional law. If they fail to do so this will still result in termination of the membership. To date no concrete agreements have been reached about the withdrawal. Its architecture, too, is still a matter of debate: a hard or a soft Brexit. A hard Brexit technically cancels all EU rules, after which the UK will entirely go it alone. The UK will then be in a genuine third-country relationship with the EU. A soft Brexit means some of the EU regulations will continue to apply to the UK. If that happens it is still quite opaque, though, which regulations will be maintained and which will be cancelled. It would generally be of great importance to both the UK and the EU if all rules on the free movement of goods and services continue to be upheld. But, as stated: all of this is still unclear right now.
The UK’s withdrawal from the EU will obviously affect a range of tax issues. EU law and, accordingly, EU tax rules will fully apply as long as the UK has not yet formally left the EU.
The following topics are relevant in terms of the tax rules:
- customs duties;
- excise duties;
- capital duty;
- various Directives on direct taxes;
- Transfer Pricing Arbitration Convention;
- State Aid rules/Code of Conduct;
- Directives on Mutual Assistance and Recovery Assistance;
- tax treaties.
Another significant issue regards the rules on levying national and employed person’s insurances. Apart from the rules the European Court of Justice’s case law needs to be highlighted as well. Before discussing these topics we have a few general notes.
2. Some general aspects
The UK leaving the EU will affect the United Kingdom, Wales, Scotland and Northern Ireland. It seemed quite likely one or more of these areas - in particular Scotland and Northern Ireland - would try and remain in the EU, but considering how things currently stand this is highly improbable. The Channel Islands and the Isle of Man are part of the UK, too, and so are other associated areas, such as Gibraltar and some Caribbean islands. As such these areas are partly governed by EU law and its application (either in full or in part) would technically be abolished.
A second issue to be taken into account when considering the tax consequences regards the two core choices the UK can make:
- The UK may join the EEA, of which Iceland, Norway and Liechtenstein form part and where a major part of EU law applies. It may also conclude an agreement like the one Switzerland has concluded with the EU. Or, alternatively, it may opt for an entirely independent status, which would definitely have to lead to treaties with the EU and with EU Member States. Nothing is clear about this to date. We expect a separate status to be realised.
- A major part of the currently applicable EU rules will have been implemented in UK national law. This particularly applies to EU Directives, which Member States must implement in their national laws. Most EU tax rules are based on Directives.
And while the secession means EU law no longer applies - unless other agreements are concluded in this respect, e.g., because the UK joins the EEA (see before) -, as long as the UK does not adapt its national laws EU law effectively continues to apply. In other words: national law derived from EU rules continues to apply until it is amended or abolished. Right now it is completely opaque as to how the UK will be dealing with this.
The following lists the tax consequences of the UK’s secession if no other agreement is concluded, resulting in a hard brexit. If the UK opts to become part of the EEA it is indicated whether the EU rules will basically be maintained.
3. Indirect taxes
A Directive and some Regulations govern the VAT in the EU and it is thus largely harmonized. Member States are free to implement VAT components at their own discretion, e.g., if it involves rates within certain margins and as regards some exemptions. As long as the UK does not adapt its national regulations the current VAT system will continue to apply. Once it has left the EU, the UK is entirely free to introduce amendments or even transfer to a different VAT system altogether. As yet we expect the UK to maintain the current system and to possibly introduce amendments in parts.
The VAT Directive will not apply should the UK join the EEA.
b. Customs or import duties
The EU Member States do not apply any import duties except where third countries are involved. As soon as the UK leaves the EU it is free to levy import duties on EU Member States, while Member States can levy import duties on UK imports. This is similar to what may be done in respect of third countries.
If the EEA is joined import duties will continue to be prohibited, so basically nothing will change.
c. Excise duties
Excise duties within the EU have been harmonized to some extent but Member States enjoy a great deal of freedom in this respect. If the UK leaves the EU it may maintain excise duties but also amend or abolish them. Excise duties are due in the state where goods are consumed. Hence, excise duties levied in the UK are relevant to all goods subject to excise duties if they are consumed there, irrespective of whether they are UK manufactured or imported into the UK.
If the EEA is joined the excise duty rules will not apply.
d. Capital duty
Unlike the Netherlands, the UK has a capital duty. In short, it is levied over accumulated share capital. The EU Capital Duty Directive applies to this tax. The UK can design the capital duty as it sees fit as soon as it leaves the EU. The capital duty is unlikely to be abolished.
If the EEA is joined the Capital Duty Directive does not apply.
4. Direct taxes
Although Member States are basically entirely free to design direct taxes such as corporate income tax, wage tax and income tax at their own discretion, some direct tax aspects are settled in Directives. As with indirect taxes these Directives have been written into national law. Hence, as long as the UK’s national regulations are not amended the UK leaving the EU does not in itself affect the implemented Directives.
b. The Parent Subsidiary Directive
The Parent Subsidiary Directive states that in situations involving parent companies and their subsidiaries (cross-border or otherwise) it is not permitted to levy withholding tax with the subsidiary on dividends paid, while these dividends may basically not be taxed with the parent company. This is subject to the provision that it regards a shareholding of at least 10%. If the UK does not amend its national regulations these rules will continue to apply. The provisions on paid dividends as laid down in in the tax treaties between the UK and the other Member States will become important if those rules are amended or abolished. A reduction of dividend withholding tax will generally be implemented, depending on the circumstances.
The UK itself, for that matter, does not levy dividend withholding tax on cross-border dividends. The Netherlands imposes a 15% tax and reduces this based on the treaty.
If the UK joins the EEA it is free to determine whether the Parent Subsidiary Directive will apply.
c. Interest and Royalties Directive
This Directive provides for an exemption of withholding tax if a company pays interest or royalty payments, respectively, provided these payments are made to a company with a shareholding of at least 25% (or if it concerns a joint parent company with a direct shareholding of at least 25% in both companies). The same applies here as what has been noted about the Parent Subsidiary Directive.
The UK levies withholding taxes on cross-border interest and royalties. The Netherlands does not have such taxation.
If the UK joins the EEA it is free to determine whether the Interest and Royalties Directive applies.
d. Merger Directive
The Merger Directive provides for a tax exemption in respect of capital gains with cross-border mergers, divisions, exchanges of shares, and transfers of assets. Nothing will change as long as the UK does not amend its national rules. This facility will most likely not be amended.
If the UK joins the EEA it is free to determine whether the Merger Directive applies.
e. Anti-BEPS Directive
The Anti-BEPS Directive intends to combat the improper use of tax rules by international corporations. Parts of this directive will come into effect in early 2019 and parts as from 2020. Conceivably, the UK could adopt parts of it (it has already done so as far as the so-called earnings stripping measures are concerned). Alternatively, parts of this directive will (or must) be implemented based on OECD agreements.
f. Mandatory Disclosure Directive
Under this directive Member States have the obligation to draft legislation under which intermediaries must notify tax authorities of any aggressive tax planning arrangements. The tax authorities must subsequently share this information with the tax authorities in other Member States insofar as multinationals are established there.
The UK has already implemented a similar regulation and it is not expected to implement this regulation.
g. Draft Directives
Four draft Directives are being prepared right now, although whether they will ever come into effect is unclear. They will no longer be of any interest for the UK, unless the UK decides otherwise (either in full or on part).
- CCTB/CCCTB Directive should lead to a univocal profit concept. We do not expect the UK to adopt it.
- FTT Directive on the implementation of the financial transaction tax. We do not expect the UK to implement this.
- Directive on the implementation of a digital services tax. We do not expect the UK to implement it.
- Directive on a fictitious permanent establishment for digital services. Although we do not expect the UK to implement it, agreement at OECD level may result in the UK realising such a regulation.
- The ATAP Directive, which is also coined the anti-BEPS Directive. It aims to combat the improper use of tax rules by international companies. The UK will conceivably assume certain components (it has already done so as regards the so-called earnings stripping measures). Parts of this Directive may (or must) also be implemented on the basis of OECD agreements.
It is unknown as to whether these Directives likewise apply to the EEA.
5. Other Regulations
a. Transfer Pricing Arbitration Convention
The Transfer Pricing Arbitration Convention provides for a procedure relating to transfer pricing disputes. Following the secession of the UK the Transfer Pricing Arbitration Convention will no longer apply. Any transfer pricing disputes arising afterwards should be settled in accordance with the mutual consultation provision as laid down in the tax treaties concluded by the UK.
The Transfer Pricing Arbitration Convention does not apply when the EEA is joined.
b. Mutual Assistance Directive and Recovery Assistance Directive
As these Directives have been written into the national regulations they will continue to apply. The UK may have the related regulations abolished or amended as from the moment of secession. Although tax treaties do contain slightly comparable provisions, their scope is far less extensive than the Directives. The OECD rules are just as far-reaching as the provisions of the EU Directive, particularly in respect of the automatic exchange of information upon taxation. It would thus be fair to say the UK will not implement any major amendments in this respect.
The Mutual Assistance Directive likewise applies to the EEA.
c. State aid
The EU treaty includes to a provision prohibiting state aid if four conditions are met. As this provision no longer applies after the secession the UK can freely implement any type of state aid it wants. The so-called Code of Conduct, which prohibits harmful tax competition, no longer applies either. Still, various action plans the OECD has developed as part of the BEPS project introduce limitations in this respect.
The state aid provisions are also valid if the EEA is joined. Not so, however, as regards the Code of Conduct.
d. Social insurances
Within the EU, social insurances are coordinated through a Regulation. In short, this provides for residents of Member States to only be insured in a single Member State. This is where they pay their contributions and receive their benefits. Since Regulations are not implemented in national rules, the UK’s national rules will apply as soon as it leaves the EU.
As very few treaties have been concluded in terms of social insurances, this will either very easily trigger a double obligation to take out an insurance or result in the total absence of an obligation to take out an insurance. The UK will most likely start to conclude treaties to prevent this from happening. There is, for that matter, a “dormant” treaty with the Netherlands. Basically, it will automatically apply again as soon as the UK leaves the EU.
If the EEA is joined the Social Security Regulation applies.
6. Court of Justice case law
Any national regulations that are possibly contrary to EU law - in terms of taxation this particularly regards the application of the free movement provisions and the state aid rules - may be brought before the European Court of Justice. Both national courts and the European Commission can do so. A European Court judgment is binding. On the back of the secession of the UK, its laws can no longer be tested against EU law and these proceedings will no longer arise. Likewise, any case law ruled on by the European Court to date will no longer apply to the UK if it secedes. One situation where this may arise regards cross-border fiscal unities that can no longer be enforced under EU law. Another issue regards the free movement of capital that may now be invoked in the relationships with third countries; this, too, will no longer be possible after the secession.
Formally, case law does not apply to the EEA. Nevertheless, the provisions on the free movement for the EEA match those of EU law and any issues may be brought before the EFTA court. Its procedures in testing EEA law correspond with those of the European Court. Hence, tests may effectively be implemented under EEA law.
Many of the consequences of the secession will clearly depend on developments and decisions made during the withdrawal process. Hardly any concrete decisions have been taken to date. Time is running out as far as this is concerned. One thing is certain, with most of the tax rules being included in the national laws of the UK and other EU Member States nothing changes as long as the UK does not amend or abolish those rules. The UK deciding to join the EEA will be decisive as well. We do not expect this to happen because the free movement of people is exactly one of the main points based on which the UK will leave. Finally, tax treaties will be playing a more important role, particularly in respect of withholding taxes, while the UK no longer being bound to European case law will be highly significant. Less is expected to change in terms of combatting the avoidance of taxation because the UK is effectively bound to the OECD’s BEPS action plans.