The Tax Implications of a Potential Brexit
By Tom Lickess, Director, International Tax
Editor’s note: The coming UK referendum on whether to remain in or leave the European Union could have serious ramifications for multinationals operating in the UK. This post is the second post of a three-part Radius series examining a potential Brexit and the related legal, HR and tax implications companies should be aware of. Read part one here.
A High Level of Uncertainty
In any tax system, a high level of certainty is required for both ease of tax administration and the efficient collection of tax liabilities. Likewise, for companies and their stakeholders, domestic and international tax-related certainty is a fundamental goal.
The UK’s EU referendum and potential exit from the European Union represent serious threats to this desired stability. And the biggest challenge businesses will face from a potential “Brexit” will be negotiating the resulting uncertainty.
UK authorities will undoubtedly reassure businesses seeking stability in the event of a Brexit, but at least some uncertainty will be inevitable. This uncertainty will persist to varying degrees both during the mandated two-year period following notification of withdrawal from the EU and subsequently, as required ongoing tax legislation changes are made in the wake of the defection.
It is not possible to precisely determine the tax implications of a Brexit, but the following implications should be considered.
Direct Tax Implications of a Brexit
Notwithstanding the jurisdictional sovereignty of direct tax regimes, as an EU member, the UK taxation power must nonetheless be exercised in accordance with EU laws (these laws are given effect in the UK by the European Communities Act). Indeed, various UK tax provisions now specifically incorporate EU fundamental freedom principles, such as those governing UK group relief of tax losses incurred in EU member states.
EU Parent-Subsidiary Directive and Interest and Royalties Directive
Perhaps the most important of the EU fundamental freedom directives are the Parent-Subsidiary Directive and the Interest and Royalties Directive. These prohibit the levying of taxes (including withholding tax) on intra-group dividend, interest and royalty receipts and payments. Following a Brexit, these directives would not apply in the UK. As a result, a UK company with subsidiaries in EU member states would need to rely on the UK’s extensive network of double tax treaties to prevent effective double-taxation on intra-group dividend, interest and royalties.
Given the UK’s position as a major foreign investment hub into the EU — with about 50% of all EU headquarters of third-party multinationals being based in the UK — the potential imposition of withholding taxes on the repatriation of dividends (for example) out of Europe via a historic UK holding structure may become an issue for a large number of multinationals.
Conversely, UK subsidiaries of EU member states would be affected by a Brexit. The UK does not impose dividend withholding tax, but it does require withholding on interest and royalties. Again, notwithstanding the UK’s double tax treaty network, withholding tax cannot be disregarded. There is, for example, a 5% withholding on royalties paid from the UK to Luxembourg.
EU Merger Directive
For high-growth multinationals, including those engaged in cross-border M&A activities, the EU Mergers Directive has provided a welcome relief from taxation. Under this directive, the transfer of assets and liabilities between companies in different EU member states can be effected with a deferral of tax (effectively the difference between market value and cost base).
In a post-Brexit environment, the UK’s domestic tax rules would apply, not the directive, leaving the potential for “exit charges” on the cross-border transfer of assets and liabilities between UK and EU companies within the same economic group.
Other Direct Tax Implications
There has been vocal UK opposition to the potential imposition of a Common Consolidated Corporate Tax Base (CCCTB), which would effectively impose a single corporate income tax rate across the EU. The CCCTB proposal has gained increased recognition over recent years as the debate over international tax avoidance has entered the public arena. Although other EU member states are also opposed to CCCTB, the UK’s absence from the EU in the event of a Brexit could open the way for the proposal to be reconsidered.
Under the provisions of the Treaty on the Functioning of the European Union, the UK government may not provide state aid. A Brexit would lift this restriction, and that could provide additional freedom for the UK to offer tax-based incentives (such as tax breaks or advance tax rulings) to foreign companies looking to relocate to or headquarter in the UK. It must be noted, however, that a post-Brexit UK may wish to join the European Free Trade Association (see below). In that case, the state-aid restriction may remain in place.
Indirect Tax Implications
Value-added tax (VAT) was introduced by the UK as a condition of entry to the European Economic Community in 1973. A Brexit would remove the UK’s existing obligation to follow the EU Principal VAT Directive. In theory, then, UK businesses and individuals would be free from the imposition of VAT. That said, more than 20% of the UK Treasury’s tax revenue is generated from VAT. It is therefore highly probable that the UK would impose an alternative sales tax on substantially similar terms.
It should also be noted that while VAT has its detractors, EU taxpayers are at present able to rely on EU law and European Court jurisprudence for guidance and certainty in that area. Under an alternative UK sales tax, businesses, taxpayers and courts would no longer be able to rely on that historical precedent, as a result of which there may be considerable uncertainty in the implementation, administration and application of any alternative UK sales tax.
This uncertainty may be compounded post-Brexit if the UK — no longer constrained by the EU VAT Directive — decides to use its newfound ability to set different rates between various goods and services.
A post-Brexit UK would likely (though not certainly) cease to be part of the EU’s customs union. In that case UK exports to the EU would be subject to customs procedures. In addition to the administrative burden of complying with these procedures, the imposition of customs duties would have a real cash cost and make UK businesses less competitive than their duty-free EU counterparts.
Finally, the cash-flow impact of import VAT must not be forgotten when considering the effects of a Brexit, though this may represent only a temporary imposition.
Capital Duties Directive
In the absence of EU legislation, the UK imposes Stamp Duty Reserve Tax (SDRT) at up to 1.5% on certain issuances of shares and securities. Pursuant to the EU Capital Duties Directive, however, and as affirmed by the Court of Justice of the European Union, the UK is limited in its imposition of this indirect (capital duties) tax.
A Brexit would allow the UK to impose indirect (capital duties) tax on the issuance of all shares and securities without regard to the EU Capital Duties Directive.
How Would the Post-Brexit UK – EU Relationship Operate Practically?
There are two existing models of how a post-Brexit UK could operate with its EU neighbors. The first is the Swiss model. Switzerland is not a member of the EU, but it can access the EU single market through bilateral arrangements. Practically, however, such agreements are unwieldy to implement and maintain, and are not favored by the EU.
The second is the Norwegian model, which is more likely to be followed by the UK in the event of a Brexit. Norway is part of the European Free Trade Association, which enables it to participate in the EU internal market. This model, however, may require that the preexisting EU (fundamental freedom) principles currently incorporated into UK law remain.
In part three of our Brexit series, we take a look at the HR implications.