On 23 June 2016, the people of the United Kingdom (UK) voted to exit the European Union (EU). The narrow margin of victory for Brexit and the strong reactions across the political and social spectrum were unexpected. This leaves the way forward unclear, especially for businesses.
There is uncertainty on the exact tax and other consequences of the withdrawal of UK from the EU, although it is expected that it will take about two years to settle down.
Tax impact of Brexit
The tax impact of an exit by the UK from the EU would depend on a number of factors, including the nature of the UK’s future relationship with the EU, which will only be clear in time. The UK is likely to follow one of the following models for its negotiations.
Type of negotiation models
Currently, it is difficult to determine the impact of Brexit, but it may be possible to obtain an idea on how the UK and the EU will operate after the Brexit. There are various models, like the Swiss model and the Norwegian model, which deal with the UK will handle post-Brexit operations with its EU neighbors.
- Swiss Model (Bilateral Arrangement Model)
- Switzerland is not a part of the EU or the European Economic Area (EEA). However, there are a series of bilateral treaties between Switzerland and the EU. These treaties enable Switzerland to participate in specific EU policies or programmes. For example, insurance, pensions and fraud prevention treaties.
- Post-Brexit, the UK may enter into a standalone free trade agreement with the EU or a series of agreements to cover individual trade sectors. The drawback of the Swiss model would be that it will not give UK the same market access which it would have as a member of the EU or EEA.
- Norwegian Model (EEA Model)
- The European Economic Area (EEA) comprises of all members of the EU together with three non-EU countries – Norway, Iceland and Liechtenstein. Members of the EEA are a part of the European Single Market. There is a free movement of goods, services, people and capital within the EEA. Membership fees are charged to the EEA to be a part of the single market.
- Post Brexit, the UK may join the European Economic Area by paying membership fees on the same basis as these other countries. Therefore, there is a possibility that the UK will retain access to the common market. The drawback of the Norwegian model is that the UK would have to pay membership fees.
There has been a lot of discussion on the changes for tax and compliance after Brexit, but it is not clear at the moment as it depends on the nature of the UK’s future relationship with the EU. However, we can explore some of the changes that could be of use as far as tax and compliance are concerned. Listed below are the tax areas, which will be affected by the Brexit.
Impact on Customs Duty
- The first impact of Brexit would fall on customs duties. The EU is a customs union as well as a single market i.e. the customs duty is regulated by EU Directives and Regulations and the duty rates are also set at the EU level. As a customs union, there are no customs duties within the EU’s territory and EU member states share common external tariffs with third countries. Collected imports duty into the UK is transmitted to the EU.
- Post Brexit, the UK would cease to be a part of the customs union and therefore cannot enjoy the relaxation provided by the EU customs union.
- Around 50% of UK’s exports are to the EU and only 10% of exports from the EU are to the UK. It is expected that the UK would enact new rules and regulations to regulate customs duty which is currently regulated through EU Directives, Regulations and Council Decisions. If so, exports between the UK and the EU would need to go through customs procedures like any other non-EU country. However, tariffs are regulated internationally by the World Customs Organisation and pursuant to the General Agreement on Tariffs and Trade. Thus, the UK must also abide by these regulations.
- The impact of a Brexit on customs duty would purely depend upon on the UK’s post-Brexit approach to customs duty. It is expected that the UK would enter into some form of customs agreement with the EU.
Impact on Value Added Tax
- Presently in the UK, VAT is levied on supplies made within the UK, intra-community transactions with other EU member states and imports. UK VAT law was required to incorporate EU directives which ensured supplies made within EU members would be treated differently or beneficially and would not be considered at par with sales made to non-member states.
- Post Brexit, EU directives will no longer be applicable and other member states will be treated as a separate country for VAT purposes. It will trigger import/export provisions; in simple words, VAT will be charged according to the provisions of supplies between the UK and non-EU member states and intra-community VAT charging provisions will be replaced. It may increase the procedural compliances and ultimately the cost of compliances. Predictably, there may not be a significant financial net impact on VAT on account of the Brexit.
- It is predicted that the UK may extend the zero rate list as the EU Directives will not be applicable. The UK will loose all the benefits of EU member states except which those which are generally applicable to non-member states such as ’The Mini One Stop Shop (MOSS)’ non-union scheme, for the supply of digital services to the consumers in EU.
- The above impacts are considered based on the current UK VAT law. The exact tax implications of the Brexit will be determined only after the actual negotiation takes place between the UK and the EU to determine the exit terms.
Impact on Corporate Income Tax
- Currently, there is no single corporate tax system in the EU as it is applicable for VAT. There exists a Parent-Subsidiary Directive between EU countries to prevent double taxation. This prohibits the levying of taxes (including withholding tax) on intra-group dividend, interest and royalty receipts and payments.
- The EU Mergers Directive simplifies the reorganisation of groups based in more than one EU member state. Mergers result in the transfer of assets and liabilities between one or more receiving companies. The Directive provides for the deferral of taxes that could be charged on the difference between the market value of the asset and the tax value during mergers of companies situated in the EU member states.
- For the EU, the Brexit may fast track the introduction of Common Consolidated Corporate Tax Base (CCCTB – a single set of regulations that companies operating within the EU could use to calculate their taxable profits) as the UK had been a major opponent to the introduction of CCCTB.
- As for Parent Subsidiary Directives, Post-Brexit, these directives would not apply in the UK. A UK-based company with subsidiaries in EU member states would need to rely on the UK’s arrangements of double tax treaties with each member state to prevent double-taxation on intra-group dividends, interest payments and royalties.
- Post Brexit, UK’s domestic tax rules would apply instead of the EU Mergers Directives which may lead to levy of ’exit charges’* on the transfer of assets and liabilities between UK and EU companies within the same group.
- If the UK joins EEA (i.e. if the UK negotiates any kind of agreement for free movement of people, goods, services, capital, etc.) there will be no major impact. Assuming the UK will not join EEA, they may amend their tax laws to revert to its former position.
*Exit charges are the charges triggered in the home jurisdiction in effect of the change in tax residence of an individual or on the transfer of taxable assets between the corporate from home jurisdiction to another jurisdiction.
Impact on Withholding Tax on Interest, Dividend and Royalty
- Many harmonising directives have been implemented by the EU to support the freedom of establishment. The most important directives are the Parent-Subsidiary Directive and the Interest and Royalty Directive.
- The Parent-Subsidiary Directive abolishes withholding tax on dividends paid between associated companies within the EU. The Interest and Royalties Directive prohibits withholding taxes on intra-group interest and royalty payments made within the EU.
- Post Brexit, the above directives would not be applicable to the UK. It could have the following impact:
- For groups with a UK parent and EU subsidiaries or EU parent and UK subsidiaries, double taxation of dividends may arise.
- Withholding tax cost could arise due to payment of interest and royalties into the EU from the UK or to the UK from EU subject to the applicable double tax treaties.
Impact on Social Security and Pension
- The EU social security regulations apply to EU nationals moving to another EU country to perform work. As per the regulations, if an EU national is paying social security and health insurance in the home country, he may be exempted from paying these contributions in the other EU country where he has been posted. The insured EU national must provide the A1 and S1 forms, where applicable, to prove he is insured in the home country.
- This would mean that UK employees who work in another member country would be eligible for exemption in that country if they are paying social security contributions in the UK. Similarly, EU nationals of another member country posted to work in the UK, can also apply for exemption from paying NIC contributions in the UK by providing form A1.
- Currently, UK pensioners living in the EU have their state pensions protected as they are upgraded annually in relation to the wage price index. Therefore, the state pension would increase every year for retirees living in the EU member state or the EEA. If the pensioner lives outside these countries, the pension is frozen at the rate at which the individual left the UK.
- Post-Brexit, the UK would no longer be a part of the EU social security system. This means that EU nationals working in the UK would no longer be eligible for exemption and may have to pay the social security contribution in the UK and in that EU member state. Alternatively, UK may sign a bilateral agreement with the EU, which for example Switzerland has, according to which it is treated as an EU member with respect to social security. In addition, UK may enter into social security agreements with individual EU countries to claim this exemption.
- In relation to pensioners, the UK government will have to decide the state pension treatment for UK retirees living in other EU member states. Such retirees could be treated as if they were to retire in any non-EU country, where their pension is frozen at the time of leaving the UK. Presumably, UK could also enter into a renegotiation process with the EU member countries where state pensions could be marked against the wage price inflation and not be frozen.
- As long as the UK remains a part of the EU, UK nationals working across EU have their pension and health care protected. After the exit, these advantages would be up for negotiation, possibly on a country-by-country basis.
Impact on Immigration
- Currently, the principle of free movement of people among EU member states exists. A national of one EU country has the right to live and work in any other member state of the EU. About 1.2 million Brits live in other EU countries and about 3 million non-British EU citizens are live in the UK. They were allowed to move freely within the EU with minimal paperwork because of the EU rules.
- Britain’s exit from the EU may change this free movement. The impact of Brexit on migration will depend on the kind of relationship that the UK would establish post-Brexit.
- One of the possibilities is that the UK could negotiate a new treaty with the EU that continues to allow free movement between the UK and the EU. Like Norway and Switzerland, UK may implement free movement as part of their economic cooperation agreements with the EU. This will limit the impact of Britain’s exit on immigration.
- Another possibility is that the EU withdrawal may result in the end of free movement and the introduction of entry formalities for EU nationals who want to work in the UK. This would mean that people moving to or from the UK would be subject to the same visa rules that apply to non-EU nationals moving to an EU member country. This will have a profound impact on migration and it would be difficult for EU citizens to live and work in the UK.
Impact on Data Protection
- The current EU data protection regime is based on the Data Protection Directive. In the United Kingdom, the EU Data Protection Directive is implemented through the Data Protection Act 1998. The European Union will be introducing General Data Protection Regulation (GDPR) which will be effective from May 2018.
- The Information Commissioner (Chief of Data Protection Act in the UK) has stated that UK businesses will continue to prepare for GDPR noting that data protection laws will remain relevant.
- Post-Brexit, if the UK chooses to leave the EU but remains part of European Economic Area (EEA) then nothing would change for the UK and it would still have to comply with the EU Data Protective Directive and upcoming General Data Protection Regulation. However, if the UK chooses to leave the EU without joining the EFTA (European Free Trade Association), then the country would be free to revise its data protection framework and deviate from EU standards and the upcoming GDPR would not apply to the UK.
In such situations, the UK Data Protection Act will need to be amended to prove that the UK is a ’safe third country’. If it fails to prove this, then data transfer to the UK would be subject to strict regulations.
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