Brexit: Major Tax Changes for Global Businesses

On June 23, the British population took the country and the world by surprise by voting in a national referendum to leave the European Union (EU).

Britain’s exit (commonly termed “Brexit”) looks likely to happen in April 2019 or later. The United Kingdom’s departure will be a dramatic trauma for it and the European economic and political union. Many areas of shared tax law and practice may be affected, including indirect and direct taxes. Companies need to start understanding their own tax exposure to Brexit and have plans ready to mitigate the risks. However, initially, the question of when, how, and, indeed, if the U.K. will depart the EU is to yet be resolved.

Brexit process and timing unclear

Much uncertainty remains ahead as to the manner and timetable for Brexit—there was no planning undertaken in the run-up to the referendum.

Under EU rules, the first step is for the U.K. government to formally notify the EU of its intention to leave. Under Article 50 of the EU Lisbon Treaty, this notification would trigger a two-year negotiation period between the United Kingdom and the remaining 27 member states. At the end of this process, all parties must agree on the terms of separation and a future trading model—which would include trade tariffs and many tax practices.

The U.K. government recently indicated that it would trigger Article 50 by the end of March 2017, which implies an April 2019 exit. However, there are many hurdles to this timetable. On Nov. 3, the British High Court of Justice ruled that the U.K. government must seek approval from the U.K. Parliament before it can invoke Article 50, holding that the U.K. government “does not have the power . . . to give notice pursuant to Article 50 . . . for the United Kingdom to withdraw from the European Union” (R. v. Secretary of State for Exiting the European Union, [2016] EWHC 2768 (Admin) (Q.B. 11/3/16) (slip op. at 32)).

Because a majority of the members of Parliament opposed Brexit, they are likely to propose many delaying amendments and changes to the U.K. government’s plans. This could add at least a year to the exit timetable. When and if those challenges are overcome, major questions still remain about the constitutional positions of Scotland Parliament and Northern Ireland Assembly that could also delay or derail Brexit.

Political issues aside, it is far from clear what post-Brexit trading model the U.K. will negotiate with the EU. The U.K. may have to leave the EU’s Single Market for goods and services as much of the reason the British voted to leave the EU has been attributed to the Single Market’s obligation for the free movement of people across national borders. An exit from the Single Market would likely mean that goods and services sold from the U.K. to the EU would then incur new tariffs and trading restrictions. This would have a damaging effect on the thousands of United States and other non-EU companies that have selected the U.K. as their base for EU trade.

Indirect tax risks

The biggest potential tax transformation post-Brexit will be for the value-added tax (VAT), which is the EU’s sales tax, levied throughout the production chain. The EU version of the VAT is based on the recommended Organisation for Economic Co-Operation and Development model. Similar versions have been implemented around the world, including in most of Africa and Asia. China and India are completing consumption tax reforms based on the EU VAT model.

All member states of the EU are obliged to implement and follow the rules of the EU VAT Directive. This covers what items are taxable; taxable date; country of taxation on cross-border supplies; allowable deductions for VAT incurred; partial exemptions; and basic VAT rate principles.

Upon exiting the EU VAT regime, the U.K. would be free to set these rules for itself. In a number of cases, the U.K. could use this freedom to its advantage. For example, the EU has restricted some of the VAT deductions available to the financial services industry. The U.K. could widen these to attract more banks and insurance companies from the rest of the EU and globally.

However, since the VAT is such a major contributor to the U.K.’s tax receipts—approximately 17% of 2015 revenues—it is unlikely that major changes are ahead. The U.K.’s VAT rate may increase from 20% to around 22%, which could help fund a cut in the corporate income tax rate as the U.K. seeks to promote itself as a low-tax destination for global multinationals.

Outside of the EU VAT regime, a series of trade simplifications in the rest of that EU will be lost to the U.K. This may cause complications for U.S. corporations that based their European operations in the U.K. to have free access to the EU. The list of issues includes:

• Exports to the EU of goods and services from the U.K. will face EU VAT when they clear into the EU, while currently they are zero-rated for VAT purposes (taxed at 0%). While this VAT should be recoverable, there could be cash flow risks and delays.
• The VAT registration exemptions on complex supply chains—including triangulation (exemption from VAT registration in all member states where goods are delivered) and VAT commissionaire structures (making sales using an undisclosed agent)—involving the U.K. will be void. This may undermine many global manufacturers’ European tax structures and leave them vulnerable to VAT liabilities.
• U.S. and other non-EU digital service (downloads of games, software, e-books, films, music, online learning, etc.) providers that have benefited from the mini-one-stop shop (MOSS) single EU VAT return to report VAT on digital services via the U.K. will have to separately register again in another EU member state.
• U.S. companies selling goods from the U.K. to Europe may have to appoint special tax agents, known as fiscal representatives, which will require bank guarantees on local VAT liabilities.

Customs duties likely to rise

As part of its exit from the EU, the U.K. will have to consider if it wishes to leave the EU Customs Union, too. This provides for the free movement of goods without border tariffs. The U.K. will be keen to do so to gain freedom to negotiate its own Free Trade Agreements around the world without EU interference.

However, this will come at a cost. It is unlikely that the EU will grant the U.K. tariff-free access to its 460 million consumers if it leaves the EU. This could mean an average rise of 4% on the costs of moving goods into and out of the U.K. to Europe. For multinationals using the U.K. for some or all of their international production chain, this will be an unwelcome bottom-line cost.

Direct taxes not exempt from change

Direct taxes, notably the corporate income tax, are outside of the purview of the EU. In theory, this should mean no changes for company taxation for businesses with operations and subsidiaries in the U.K.

However, the EU exerts considerable influence indirectly. Companies depending on payments into the U.K. from abroad may suffer new withholding tax cash flow problems. The EU Parent-Subsidiary Directive and the Interest and Royalties Directive prevent such tax losses, but these would no longer apply to the U.K. outside of the EU.

One key EU initiative the post-Brexit U.K. will miss out on is the proposed harmonization of direct taxes, which may be an advantage. The EU is set to propose limiting the competitive tax planning opportunities its member states have been using to attract global multinationals through initiatives such as the Common Consolidated Corporate Tax Base. The U.K. would now fall outside of this proposal, again enhancing its position as a tax-friendly global base.

Tax planning for Brexit

Now that a potential exit date has been announced, April 2019, it is time for multinationals to start planning for the prospective tax changes—even though they will not be fully determined until trade model negotiations are more advanced. Suggested measures include:

• Establish a company task force with relevant stakeholders in the business’s tax affairs. This should include representatives from tax, finance, procurement, sales, and planning.
• Scope out international supply chains with U.K. and EU VAT registrations. This will help determine where there may be cash flow risks and losses.
• Plan for alternative structures for supply chains and determine likely costs/benefits of the changes.
• Map out international holding company structures, with flows of payments, dividends, interest, and royalties. These should be compared to tax treaties to ensure that the withholding tax losses will not be triggered post-Brexit.
• Present the outcome of the above to the C-suite-level executive to gain his or her understanding of the risks, and ensure the organization has worked through all potential scenarios for when Brexit outcomes are clarified.

Richard Asquith, vice president for Global Tax Compliance at Avalara, a tax software company, is a U.K. Chartered Accountant based in London, responsible for helping businesses understand and manage their tax compliance obligations as they enter or expand into new markets.