The precise impact of a Brexit on UK tax law is not possible to determine without knowing the terms of the exit negotiated by the UK with the EU and future government decisions. There are various ways the relationship between the UK and the EU member states might operate following a UK exit from the EU and such a relationship might take two years (or even more) to establish.
A discussion of the options available is beyond the scope of this note, but the main alternatives include:
- The UK joining the European Free Trade Association and the European Economic Area, and so retaining access to the common market on the same basis as Norway, Iceland and Liechtenstein, and continuing to contribute to EU spending
- The UK negotiating either a standalone free trade agreement with the EU, or a series of agreements covering individual trade sectors (in a similar way as Switzerland has)
- The UK negotiating an ongoing customs union with the EU (in the manner that Turkey has).
Tax issues and potential implications of a Brexit include:
- Corporate transactions and withholding taxes
- Some EU directives are aimed at removing tax obstacles from businesses operating across the EU; the Parent-Subsidiary Directive eliminates withholding tax on dividends paid between associated companies within the EU and the Interest and Royalties Directive eliminates withholding tax on interest and royalty payments between associated enterprises within the EU. If those directives were no longer to apply, double taxation of dividends could arise for groups with a UK parent and EU subsidiaries or EU parent and UK subsidiaries and there could be withholding tax costs on payments of interest and royalties into the EU from the UK and vice versa (subject to applicable double tax treaties). Alternatively, the UK may re-visit some of its withholding tax rules and perhaps abolish the requirement to withhold tax on interest given the gradual erosion of the practical incidence of withholding in recent years and the fact that several other European jurisdictions do not levy withholding tax on interest.
- The UK may no longer be required to give effect to the Merger Directive which is designed to remove fiscal obstacles to cross-border reorganisations.
- The Capital Duties Directive prevents member states from imposing tax on the raising of capital by companies, such as share issues. This has meant that the UK has had to restrict the scope of its 1.5% stamp duty reserve tax charge on share issues into depository receipt issuers and clearance services. Depending on the terms of any Brexit, this charge could be imposed more widely again.
- Corporate tax systems
- Direct taxes are a matter for the UK but the UK government must exercise its powers in creating and maintaining our corporation tax system consistently with EU law, the principle of fiscal neutrality and, in particular, the fundamental freedoms of movement of capital, people and services and of establishment. The UK has over the years been required to amend its tax law on several occasions to comply with EU law (for example its corporation tax group relief system). Decisions of the Court of Justice of the European Union, even where another member state was party, have affected the design of important aspects of the UK's corporate tax system such as its controlled foreign company rules.
- If the UK were to join the EEA then it would continue to be subject to these restrictions and enjoy the benefit of the EU fundamental freedoms Assuming the UK does not become part of the EEA, it is uncertain to what extent the UK would amend its tax laws to revert to its former position (distinguishing between UK and non-UK taxpayers) if relieved of the constraints of EU law (and conversely whether the tax systems of EU member states would discriminate against UK businesses). Any temptation to restore the UK tax system to one which favours domestic companies might be counterbalanced by an incentive to maintain the UK's attractiveness as a place for multi-nationals to do business and as holding company jurisdiction.
- For some years, the EU commission has been pushing for full harmonisation of corporate tax notably through the introduction of a Common Consolidated Corporate Tax Base and more recently through a uniform response to the recommendations made by the OECD in its Base Erosion and Profit Shifting (BEPS) reports last year. While the UK has been a supporter of the BEPS recommendations, it has been an opponent of the CCCTB leading some to suggest that a Brexit could result in an acceleration of its introduction.
- State Aid
- The prohibition on State Aid (a branch of EU competition law which prevents member states from giving subsidies and other aid to particular businesses or sectors) has been used to scrutinise the design of some EU tax systems and tax rulings given to multi-national enterprises. In certain high profile cases, the EU Commission has already decided that tax rulings were overly generous to the multi-national taxpayer and ordered recovery of the estimated ‘underpaid’ tax from the companies involved (though cases are on-going and subject to appeal).
- Following a Brexit, the UK may be free to grant state aid as it chooses although if it is not subject to state aid rules itself, it will likely have no means to have other member states challenged over their tax ruling practices and tax systems.
- UK VAT law derives from European law and although the UK may no longer be required to give effect to the VAT Directives and regulations after any Brexit, it seems likely, in the first few years at least, that the UK would maintain a parallel VAT system (not least because of the confusion and cost changes would cause). Once the UK was out of the EU, there would likely be technical changes relating to, for example, methods of reclaiming VAT from EU tax authorities (for example the VAT incurred by businesses in other member states of the EU).
- The UK VAT (or other sales tax) rules would no doubt change over time, perhaps most immediately there might be an extension of the zero rate and then possibly a change in the main rate. New rules would have to be developed to replace or modify the existing VAT rules which distinguish between supplies made to or from the EU member states. Among technical issues arising on the new (parallel) VAT system would be the extent to which case-law on pre Brexit VAT was relevant.
- The UK would presumably lose access to the EU 'one-stop shop' mechanisms that are being introduced in various areas of VAT to remove the burden for a business which would otherwise be required to register for VAT in up to 28 jurisdictions (though for electronic and telecoms providers, the non-union mini one-stop-shop may still be available). Triangulation (goods moving within the EU in the course of a supply chain including VAT registered businesses) is another simplification measure which may not be available to suppliers.
- The risk of double taxation or double non-taxation arising from a divergence between EU VAT law and a UK equivalent may well incentivise the UK to maintain a VAT system which is substantially aligned with the EU's.
- Customs union
- The EU is a customs union as well as a single market and consequently, there are no customs duties within the EU's territory and member states share common external tariffs with third countries.
- Assuming that a Brexit would mean the UK leaving the customs union, exports between the UK and the EU would need to go through customs procedures and customs duties may be imposed. Although the level of customs duties may in many cases low (being the World Trade Organisation's 'most-favoured nations' duties) they would represent a disadvantage for UK competitors as compared with competitors within the EU.
- It is possible however that the UK or EU could, in time, enter into a free trade agreement with no or very low customs duties.
- Social security contributions for internationally mobile employees - The UK is part of the EU social security contributions system which means that UK workers who work in another member state are only liable to pay social security contributions of that member state. Following a Brexit, unless the UK agrees to be part of the EU system, workers may be liable to double social security contributions in both the UK and the EU member state in which they are working.
- Other international influences - Following a Brexit, the UK would still be influenced by other international bodies such as the OECD with its Base Erosion and Profit Shifting (BEPS) project, the Common Reporting Standard (the global standard for exchange of financial account information between tax authorities) and other transparency measures, such as country-by-country reporting. The EU has recently proposed its own draft directive which seeks to implement many of the BEPS proposals as well as others. Although the UK might not be obliged to implement this Directive, it would still be subject to the same international anti-tax-avoidance influences that provoked the proposal of the directive.