The signing of the Withdrawal Agreement between the UK and the EU has avoided an immediate “no deal” Brexit and provided some clarity on relations with the EU in the short term. Once the UK exited at 11 pm on 31 January 2020, the UK and EU entered a “transition period” until 31 December 2020 (and possibly later, although the UK government has indicated that it is not planning an extension), with the aim of entering into a further agreement during that time to regulate our future legal and economic relationship with the EU. This briefing focusses on the key tax implications of Brexit for businesses.
The UK has a relatively business-friendly tax regime, with a wide treaty network and attractive domestic rules (including a low headline corporation tax rate, no dividend withholding tax, and CFC and dividend exemption regimes which were reformed around 10 years ago to make the UK more competitive). This should be largely unaffected by Brexit, and we can expect the current government to plug any “gaps” created by Brexit to ensure the UK remains competitive. Since the 2016 vote, the government has emphasised that the UK is “open for business” and will make the most of the opportunities created by Brexit. However, the UK cannot control domestic tax legislation in other jurisdictions or double tax treaties (“DTTs”) to which it is not a party, where EU status can sometimes create a favourable tax position. We have summarised some of the key areas in more detail below.
- Withholding tax. Under EU Directives, payments of dividends, interest and royalties may be made by and to UK companies free from local withholding tax where the payer or payee is resident in an EU member state and prescribed conditions are met. During the transition period, generally, the UK will continue to be treated as an EU member state for the purposes of most EU laws, and to the extent that domestic law in an EU member state implements EU law. As a result, there should not be any immediate change on 1 February 2020 to the withholding tax position (including exemptions) where companies have relied on EU Directives to mitigate local withholding tax on intra-EU payments of dividends, interest or royalties.
However, the UK will not be an EU member state from 1 February 2020 for any other purposes, and immediate tax consequences may arise where concessions or benefits currently exist under domestic legislation (not implementing EU law) or certain DTTs. For example:
(i) some jurisdictions exempt from withholding tax, as a matter of domestic law, payments made by local entities to recipients in EU member states. Such exemptions may be unavailable from 1 February 2020; and
(ii) certain treaties between EU member states and the US which include a “limitation on benefits” provision, which restrict treaty benefits in certain cases depending on the taxpayer’s ultimate owner(s). Where reliance has to date been placed on the presence of investors in the EU to meet these requirements, the ability of entities with UK investors to claim treaty benefits may now be slightly more complicated.
Following the transition period, businesses should consider whether relief would otherwise be available (including under an applicable DTT) to mitigate any withholding tax that may arise on payments, in the absence of the EU Directives. Although the UK has one of the world’s largest DTT networks, certain of those treaties only reduce (rather than eliminate) the withholding tax payable (the DTTs with Germany and Italy are notable in this respect). Depending on the outcome of the exit negotiations, there may be tax leakage on payments to or from residents in EU member states going forward.
- Group structures. The inclusion of an entity in a non-EU member state in a group structure which includes entities in EU member states may break local tax grouping / consolidation arrangements, or adversely impact on the availability of local tax reliefs or exemptions, in those EU member states. As noted, from 1 February 2020 the UK will no longer be an EU member state, which may (depending on the relevant domestic law) have the effect of breaking such arrangements or adversely impacting on the availability of such reliefs or exemptions even during the transition period.
- Reorganisations. Under existing EU law, certain reliefs or deferrals are available when implementing reorganisations involving UK companies. These reliefs or deferrals may be clawed back when the UK ceases to be treated as an EU member state. Further, following the transition period and depending on the outcome of further exit negotiations, UK companies may not be able to rely on the reliefs available under the EU Mergers Directive or Cross Border Mergers Directive.
- Indirect taxes. VAT, insurance taxes, customs duty, excise duty and customs arrangements will all be impacted by Brexit, and the long-term position will be affected by further negotiations between the UK and EU. The Withdrawal Agreement implements a “stand still” during the transition period, in which EU VAT directives will continue to apply to goods supplied between the UK and EU member states, and returns and refund applications in relation to the transition period will need to be submitted and finalised shortly afterwards. Some arrangements involving indirect taxes between Northern Ireland and the Republic of Ireland beyond the transition period have also been agreed. The UK has proposed amendments to domestic VAT legislation to enable its continued operation independent of EU VAT directives and EU jurisprudence after the transition period. However, further arrangements regarding VAT may be negotiated with the EU.
- EU Disclosure regime: The UK will continue to be subject to EU Directive 2018/822 (“DAC6”), on the disclosure of cross-border arrangements featuring certain “hallmarks” of tax avoidance, during the transition period. The UK has now implemented DAC6 under domestic law and HMRC has indicated that the rules will remain in place post-Brexit, although HMRC has also acknowledged in discussions that the rules may need to be revised following the transition period.
- BEPS: The EU is in the process of introducing anti-avoidance directives to implement the outcomes of the OECD Base Erosion and Profit Shifting (“BEPS”) initiative. These include controlled foreign company (or CFC) regimes, hybrid mismatch rules, exit taxation rules, corporate interest restrictions and a general anti-abuse rule. UK domestic law already contains many of these rules, which will continue to apply during and beyond the transition period in the normal way. Following the transition period, the UK will have more flexibility as to how it will implement BEPS. Given the UK’s enthusiasm to be at the forefront of BEPS, it seems unlikely that the UK will adopt a less rigorous implementation of BEPS following its departure from the EU. However, the anticipated trade negotiations with the US may place the UK under pressure in terms of pressing ahead with measures such as the proposed Digital Services Tax (which the US perceives is targeted at US multinationals).
- State aid: The EU prohibitions against state aid which apply, amongst others, to the provision of selective tax advantages and preferential tax regimes, will continue to apply during the transition period, and will also continue to apply after the transition period to certain measures involving Northern Ireland. However, if further agreements with the EU do not regulate state aid, the UK may otherwise be free to provide state aid domestically, subject to other international obligations such as WTO rules. In a tax context, this will be relevant to, for instance, the Enterprise Investment Scheme, Enterprise Management Incentive schemes, Social Investment Tax Relief, R&D tax credits and the former “finance company exemption” from the CFC regime.
- Stamp taxes / FTT: Although technically payable under domestic law, the UK has not collected a 1.5% Stamp Duty Reserve Tax charge on issuing shares into a depositary or clearance service following a decision of the European Court of Justice that such a charge would be incompatible with EU law. In the 2017 Budget the UK government indicated that it would not reintroduce this charge following Brexit; it remains to be seen whether the government will take the same view beyond the transition period. Brexit also raises the question as to whether the EU will be able to resurrect the proposed financial transactions tax (“FTT”), given the UK’s opposition to its introduction. However, as many other EU Member States are not yet supportive of the FTT, it seems unlikely that Brexit will be a turning point on this.