Brexit: the tax implications

In brief

The tax impact of the vote for an exit by the UK from the EU will depend on a number of factors, including, most importantly, whether the UK leaves on the basis of a “hard” or “soft” Brexit and the nature of the UK’s future relationship with the EU.

In the short term, the impact of the European Union (Withdrawal) Act 2018 (the Withdrawal Act) means that much existing EU law will continue to apply in the UK after “exit day” as if it were part of domestic law and previous decisions of the CJEU will continue to be relevant to the application of those laws. However, there are exceptions, most notably for customs duty. If the draft Withdrawal Agreement with the EU is concluded, then much of EU law, including customs duty and VAT, will continue to have effect in the UK until at least 31 December 2020.

However, in the longer term, the UK will not be bound by EU Regulations and EU Directives which have been implemented into domestic law and will, in principle, have greater freedom to legislate in those areas free from the constraints of EU laws. For an explanation of the effect of the Brexit on UK law generally, see our article: Brexit: the legal implications.

In addition, unless the UK agrees otherwise as part of its future trading relationship with the EU, the application of the EU fundamental freedoms and other EU legal principles will, in principle, have less impact on UK tax rules going forwards, again providing greater freedom to a future UK government to legislate in those areas.

However, the impact of Brexit will, in practice, be minimised by the economic and political reality of the need to adhere to business friendly EU Directives, to raise revenue through taxes such as VAT and to fill the vacuum in customs duty legislation, for example. Indeed, in the short term, the impact of the Withdrawal Act will be to ensure the UK remains aligned with most areas of EU law unless and until positive decisions are made to depart from it. Nevertheless, there may still be increased administrative costs for UK businesses in complying with different systems of taxation.

More generally, not being in the EU will remove the UK’s powers to influence EU level tax matters such as its ability to oppose / influence the enhanced co-operation procedure (ECP) financial transaction tax (FTT) proposal, which could be adverse to UK businesses that could suffer EU FTT.

Of course, following Brexit, the UK will no longer be a Member State for the purposes of a number of tax-related EU Directives, such as the Parent and Subsidiary and the Interest and Royalties Directives. This may result in the imposition of withholding taxes on payments between EU group members and UK group members.

Nevertheless, Brexit will have no impact on the UK’s extensive double tax treaty network, which is not based on EU Membership. The UK will, therefore, still benefit from and be bound by the double tax treaties already in force.

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Introduction
  • Membership of the EU has made the UK subject to a number of EU Directives and Regulations which have sought to provide a more common system of taxation between EU Member States in relation to a range of matters.

    These range from areas such as customs duties (a harmonised EU tax effected by EU Regulations), VAT (essentially a harmonised EU tax, albeit one which requires domestic legislation), directives dealing with cross-border dividends, interest and royalty payments and cross-border mergers as well as administrative directives, such as those requiring information gathering and sharing in relation to financial payments.

    In addition, the effect of the fundamental freedoms on direct tax rules has been particularly significant, striking down domestic tax rules and restricting the options of UK governments to legislate new rules, such as those in relation to cross-border group relief, the operation of controlled foreign company rules and double tax relief.

VAT
  • The UK’s VAT system is underpinned by EU law. Based on EU VAT Directives, the UK is obliged to have a VAT system that is governed by EU law and principles. Although UK VAT only applies to supplies that are made in the UK, the EU Directive that governs VAT ensures that supplies made between EU Member States are treated differently to those made outside of the EU.

    The VAT Directives have been implemented in the UK through the introduction of domestic UK legislation. Brexit will not cause the UK legislation implementing the VAT Directives to automatically fall away and VAT will continue to apply in the UK. The effect of the Withdrawal Act is to ensure that, as regards the existing VAT law, it will continue to be applied and construed in accordance with pre-Brexit principles and decisions of the CJEU.

    However, Brexit will result in the UK no longer being part of the EU for VAT purposes. As such, from the perspective of other Member States the UK (and the Isle of Man) will become a third country for VAT purposes post-Brexit. This will have implications for the imposition of VAT on cross-border supplies involving the UK. In particular, import VAT will become chargeable on the movement of goods between the UK and the EU.

    The government has published a number of amending Statutory Instruments to make changes to UK VAT law post-Brexit to ensure that it continues to operate effectively. For example, “acquisition VAT” on the acquisition of goods from other Member States will be replaced by “import VAT” and provision have been made for traders to account for import VAT on their regular VAT returns rather than on import.

    Whilst the Withdrawal Act will mean that the UK VAT law will, on the whole, continue to be interpreted in conformity with pre-Brexit EU law, in the longer term.

    Brexit will free the UK government from the requirement to comply with the VAT Directives, therefore allowing the UK to set its own rates of VAT (without restrictions) and decide which supplies might be zero-rated, for example.

Customs duty
  • Customs duty is an EU tax. It is imposed directly by EU Regulations. Broadly speaking, customs duty is charged on the import of all goods into the customs territory of the EC when those goods are released for free circulation. It is charged on import and collected by the Member State into which the goods are imported.

    Subject to the terms of the draft Withdrawal Agreement, Brexit will mean that the EU Customs Duty Regulations will no longer apply to the import of goods into the UK but that, since the UK will no longer be part of the EU customs union, EU customs duties will need to be applied on the import of goods from the UK into the EU Member States. The Taxation (Cross-border Trade) Act 2018 specifically provides for EU customs duty not to be retained EU law and for its replacement by UK customs duty.

    In practice, the impact of Brexit on customs duty will depend on whether the UK and the EU reach an agreement on post-Brexit trade as envisaged in the draft Withdrawal Agreement.

The fundamental freedoms
  • Despite the fact that the UK retains competence in direct tax matters, the ECJ has established that Member States must exercise their direct taxation powers in conformity with EU law. EU law contains a general prohibition on discrimination based on nationality, and more specifically the free movement of workers and capital, the freedom to provide services and the freedom of establishment. Therefore, the UK’s taxation powers have been restricted by the need to comply with the fundamental freedoms.

    A finding of discrimination means that a tax rule will either be construed in conformity with EU law or be disapplied against the relevant taxpayer.

    As a result of Brexit, the UK will therefore be free, in principle, to provide discriminatory incentives and reliefs to UK companies, as it would no longer be prevented from discriminating against non-UK resident companies. It could reverse some of the changes introduced to comply with the fundamental freedoms, such as those dealing with cross-border losses, transfer pricing rules and CFC rules. Future legislation will not be constrained by the need to be “EU proof”. In practice, however, “non-discrimination” provisions in certain tax treaties and developments at an OECD level may limit this freedom to some degree.

    The corollary of this is that UK companies will not have recourse to the CJEU to challenge measures in other EU Member States that may operate to the disadvantage of UK businesses.

Impact on specific EU Directives
  • The UK will no longer be required to give effect to a number of specific EU Directives, including the Parent/Subsidiary Directive, the Interest and Royalties Directive, the Mergers Directive, the Capital Duties Directive and the Mutual Assistance Directives. Following Brexit, the UK will no longer be an EU Member State for the purposes of applying such Directives, leading to potential immediate detrimental impact on the payments and transactions affected by these Directives made to UK companies.

    In this context, it is worth noting that half of all European headquarters of non-EU firms are in the UK, with the UK hosting more HQs than Germany, France, Switzerland and the Netherlands put together (Global Counsel, “BREXIT: the impact on the UK and the EU”, June 2015). Whilst in some cases equivalent bilateral agreements exist, in the absence of such equivalent bilateral agreements, the UK will no longer be such an attractive option for a European HoldCo, if the HoldCo cannot receive dividends, royalties and interest without suffering overseas taxes.

    The Parent/Subsidiary Directive abolishes withholding taxes on the payments of dividends between associated companies in different Member States and the double taxation of parent companies on their subsidiaries’ profits. Brexit will potentially affect dividends from companies based in other EU Member States to their UK parent company, as the UK parent company will no longer benefit from the Directive. The actual impact will differ from jurisdiction to jurisdiction depending on the terms of bilateral tax treaties entered into by the UK. However, dividends from UK companies to parent companies in other Member States will not be affected as the UK does not generally impose withholding taxes on dividend payments.

    Brexit will, in principle, remove the benefit of the Interest and Royalties Directive, meaning that payments of royalties and interest to a UK company from an associated company in an EU Member State may be subject to withholding taxes

    Again, the impact will differ from jurisdiction to jurisdiction based on the terms of any bilateral double tax treaty. Equally, UK withholding tax of 20% may become applicable to royalty and interest payments made by UK companies to associated companies based in the EU, depending on the terms of any double tax treaty.

    The UK will no longer be obliged to comply with the Mergers Directive. The Mergers Directive is intended to remove fiscal obstacles to cross-border reorganisations. For example, where a company transfers assets or liabilities to a company in another EU Member State under a merger, taxation of the difference between the real value and the value of those assets or liabilities for tax purposes can be deferred. UK companies involved in a cross-border merger may no longer benefit from the application of the Mergers Directive by EU Member States, however. This may have a detrimental impact on any post-Brexit restructuring of businesses. See our article, “Brexit: tax issues on business restructurings”.

    Although the UK does not levy any capital duty, the restrictions contained in the Capital Duties Directive have impacted the UK’s ability to levy SDRT on certain transfers of shares, including the transfer of shares into clearing systems; these restrictions would, in principle, no longer apply following Brexit.

    The close involvement of the UK in the current EU approach to tax transparency and the common implementation of BEPS, suggests that, although the Directive on Administrative Cooperation in Taxation (DAC) will, in principle, cease to apply following Brexit, this may have limited practical effect. The UK is committed to greater tax transparency, including the Common Reporting Standard (CRS) and Country by Country Reporting, and it is highly likely that the UK will continue to implement the same information exchange and tax transparency regimes as those in the EU. However, there may be more flexibility for the UK post-Brexit, in that it may simply implement the CRS on its own terms rather than applying the EU amended DAC, which goldplates certain aspects of the CRS.

    In addition, the UK has fully supported the Organisation for Economic Co-operation and Development's (OECD) Base Erosion and Profit Shifting (BEPS) project and is committed to implementing its recommendations whether as part of a wider EU implementation or otherwise. However, on a practical level, Brexit will mean that the UK will most likely require more domestic and bilateral agreements to apply mutual assistance measures between the UK and EU Member States. For example, the UK may no longer benefit from the exchange of tax rulings, which could limit the UK’s ability to get information on/challenge international structures in the absence of equivalent bi-lateral measures.

    As such, the UK’s double taxation agreements may become increasingly significant following Brexit given that the UK has concluded double taxation agreements with all present EU Member States.

    Finally, the UK will no longer have to address issues arising from the proposal for a Common Consolidated Corporate Tax Base (CCCTB).

Social Security agreements
  • As a member of the EU, the UK is a signatory to the EU Social Security agreements, which essentially provide a mechanism for EU individuals who work in different EU countries to only be subject to the social security regime of one of those countries. Following Brexit, the UK will need to re-sign such agreements in its capacity as a non-EU member (which for example Switzerland has done, under which it will effectively be treated as a member of the EU for social security purposes).

For further information, please refer to Brexit: the legal implications.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.