Brexit – The UK and International Tax Consequences
The political, economic and constitutional fallout of the UK’s referendum decision to leave the European Union (Brexit) will continue for some time. In addition to considering some of the possible domestic UK tax implications of Brexit, this OnPoint also considers some of the potential tax implications from the perspective of the U.S. and certain European jurisdictions. Since much will depend on the relationship the UK negotiates with the EU in the coming months and years, and the future domestic tax policy adopted by the UK government, what follows should serve only as an illustration of possible future changes. Taxpayers should closely monitor developments in this area.
Much commentary has focused on the consequences of Brexit on the UK market and on UK taxation. However, there will undoubtedly also be material tax implications for taxpayers in other jurisdictions. In short, any exemptions from tax in other EU member states or treaty jurisdictions which rely on the UK being a member of the EU are likely to be affected. Set out below are some initial thoughts as to potential international tax issues to bear in mind.
In brief, Brexit is unlikely to have a material, immediate impact on UK tax policy. The UK remains a full member of the EU until formal talks on secession are complete and any resulting agreed arrangements become effective. Any such agreement could take two or more years following the UK government’s formal commencement of the secession process. In addition, George Osborne, the UK Chancellor, recently stated that no post-Brexit budget will take place until the Conservative Party chooses a new Prime Minister in October 2016.
Potential U.S. Tax Consequences
- U.S. Tax Treaty Eligibility for European Companies
Brexit may have an effect on double tax treaty eligibility for European companies (including investment vehicles in EU member states such as Irish ICAVs). U.S. tax treaties generally require that a company claiming treaty benefits meet certain ownership requirements, often by requiring ownership by persons in the country in which the company is organised. In the case of U.S. treaties with EU members, ownership by persons in other EU member states can often satisfy this requirement for the purposes of providing certain treaty benefits (referred to as claiming “derivative benefits” under the treaty). Accordingly, when the UK is formally no longer an EU member, companies that relied on UK owners as members of the EU could lose the ability to claim derivative benefits.
That said, even after it leaves the EU, the UK may be able to continue its membership in the European Economic Area (EEA) thereby maintaining an association with the EU like Norway, Iceland and Liechtenstein. In that case, depending on the treaty, owners who are residents of the UK would still qualify for derivative benefit status, because some treaties accord derivative benefits if the owner is a member of the EEA (including the treaties with Belgium, Bulgaria, Denmark, Finland, Germany, Iceland, Malta, Netherlands, Sweden and Switzerland).
- The UK as a Holding Company Jurisdiction
The UK has become popular in recent years as a holding company jurisdiction, including for U.S.-based companies that have undergone “inversions”. Many of the benefits of the UK as a holding company should remain post-Brexit, such as the favorable UK domestic tax regime, the U.S.-UK tax treaty, and the non-tax benefits London has to offer. Some benefits may even be enhanced as a result of Brexit (such as greater control over its domestic corporate tax policy as explained further below).
However, some of the benefits of the UK as a holding company jurisdiction are contained in EU law which may not apply post-Brexit. Notable Directives that could be affected by Brexit include, in particular, the Parent – Subsidiary Directive (as to which see further below) and the Interest and Royalty Directive which prohibit withholding taxes on intra group interest, dividend and royalty payments. It remains to be seen if the potential higher withholding taxes on dividends and other payments from member states of the EU may erode the advantages of the UK as a potential destination for U.S. companies seeking inversions. The inability to continue to be able to rely on such Directives could result in a UK holding company ceasing to be as tax effective as it is currently although in most cases (but not all) bilateral tax treaties may avoid withholding taxes. For example, the UK tax treaties with Germany and Italy do not eliminate dividend withholding tax. UK subsidiaries could also incur additional withholding tax on certain types of royalty or interest payments to EU parent companies or affiliates.
Potential European Tax Consequences
Many EU jurisdictions, such as Germany, provide beneficial tax rules for foreign taxpayers which are tax resident in an EU member state (such as the UK) as well as for EU taxpayers which make cross-border investments into companies tax resident in other EU member states (such as the UK). Once the UK leaves the EU, these beneficial rules will no longer apply. By way of example, and noting that similar consequences may arise in other EU jurisdictions, notable consequences may include:
- Application of CFC-Rules
Under the controlled foreign companies rules (CFC-Rules) in other EU jurisdictions the UK could be considered to be a low tax jurisdiction because the corporate income tax rate is below 25 per cent. As a consequence, EU shareholders of UK companies that generate passive income (e.g. interest/dividends), would generally be subject to the CFC-Rules.
However, such CFC-Rules in EU jurisdictions generally provide for exceptions on which UK companies have often relied by virtue of the UK’s EU membership which may not apply following Brexit. Consequently, investments by EU taxpayers into UK companies may become subject to the CFC-Rules in other EU jurisdictions.
- Taxation of UK Dividends
Based on the Parent-Subsidiary Directive, there is no withholding tax on dividend payments made to a parent company located in the EU. Brexit may deprive UK parent companies of this withholding tax exemption (unless the UK adopts an EEA model). However, double tax treaties concluded by the UK will remain applicable following Brexit and could allow UK parent companies to benefit from reduced rates of withholding taxes.
Moreover, Germany exempts dividends paid by EU subsidiaries from German Trade Tax (charged at between 7-17%, depending on the municipality). Following Brexit, the requirements for dividends paid by UK subsidiaries to a German taxpayer to be exempt from Trade Tax will become more onerous. In particular, dividends paid from UK holding companies will likely become fully subject to Trade Tax.
- Taxation of Capital Repayments
By virtue of the UK’s membership in the EU, repayments of capital by UK companies to German shareholders are currently not subject to tax provided certain conditions are met. After Brexit, unless the UK adopts an EEA model, such capital repayments by UK companies to German shareholders could become fully taxable for German Corporate Income and Trade Tax purposes.
- Taxation of Cross-Border Restructurings
Based on the Merger Directive, Germany allows for income tax-neutral cross-border mergers and other restructurings of EU companies. Similarly, there is no taxation in Germany when a German company transfers its seat or effective place of management to another EU member state as long as a domestic permanent establishment remains in Germany. Further, certain restructurings involving EU companies are exempt from German Real Estate Transfer Tax. Following Brexit, these beneficial tax rules will no longer be available for UK companies unless the UK adopts an EEA model.
- Transfer Pricing, Exit Tax and Inheritance Tax
Brexit will also have a negative impact on the Transfer Pricing rules (i.e., higher burden of proof requirements due to the fact that the Directive on Administrative Cooperation and the Arbitration Convention will cease to be applicable), the exit taxation for private individuals (i.e., the exit taxation will be triggered immediately and can no longer be deferred or, depending on the country involved, will be deferred only after provision of bank guarantees) and Inheritance Tax (i.e., shares in EU companies benefit from certain tax-allowances, which will no longer be available in relation to UK companies).
Domestic Tax Consequences
There is unlikely to be any immediate impact of the Brexit vote on UK tax policy, as the UK is still a full member of the EU until formal talks on secession are completed and any resulting agreed arrangements become effective. EU Directives implemented by statute will remain part of UK law unless changed by further UK statute. Nevertheless, it is worth noting the following.
- Potential for Increased Flexibility of UK Tax Policy
Post-Brexit, the UK should be free to avoid some of the EU wide tax measures the UK government doesn’t like – such as the current proposals to harmonise corporation tax rules (the Common Consolidated Corporate Tax Base). In addition, it would not need to comply with the proposed Anti-Tax Avoidance Directive which includes measures which go beyond the OECD’s BEPS proposals. Unless the UK decides to continue as a member of the EEA, it would also be free to implement tax laws that constitute state aid or contradict EU freedoms or are discriminatory against EU companies. This could lead to an even more competitive tax regime.
VAT has been harmonised in the EU since 1977. If the UK leaves the EU it would be free to change how VAT is charged or implement a different or additional turnover tax. However, VAT is a big revenue raiser and so it seems unlikely that wholesale changes would emerge in the near to medium term.
- Customs Duties
Changes could arise to Customs Duties. It seems likely that the UK would leave the customs union given that one of the key benefits of Brexit is perceived to be the ability to negotiate new free trade agreements. As a result exports between the UK and the EU may need to go through custom procedures and significant changes to rates of duty may arise.
- Stamp Duty
The UK’s stamp duties should not be directly affected by Brexit but since the Capital Duties Directive may no longer apply, it is possible that stamp duty could be reinstated in relation to new share issues.
The outcome of the UK referendum does not require an immediate reaction from a tax perspective. However, as the UK’s withdrawal from the EU progresses, and while an element of uncertainty remains regarding future tax policy, taxpayers should remain cognisant of the direction of travel and should take into account the possible significant changes on the horizon when undertaking transactions and implementing their tax strategies.