The Brexit Vote and the Future of Business Relations with the UK
Cheri Lozoraitis, International Tax Specialist
The Brexit vote, last spring, sent an immediate ripple of volatility through the currency and stock markets, and incited a great deal of political turmoil. In the days and months that followed, the value of the Pound dropped substantially, stocks plummeted, and the British Prime Minister tendered his resignation. Many people are now asking how the British vote to exit the European Union (EU) will likely impact business both into and out of the United Kingdom (UK). There is no short answer to this question. U.S. companies that sell to, buy from, or operate in the UK or EU, or are engaged in their financial or stock markets, are likely to experience some financial effects, but the nature and extent of those effects is still to be determined.
The obvious statement is that the UK’s vote to leave the EU creates a period of uncertainly. We’ve seen some of the short-term effects. The longer-term impact will depend on the specifics of the UK’s exit. Some areas that businesses will want to watch include: changing trade tariffs and customs duties on UK imports and exports, slower UK and EU GDP growth, increased UK deregulation (which may offer some positives in the long run), and changes to the movement of people between the UK and remaining members of the EU.
It will be important for U.S. companies to monitor the developments as they unfold, and stand ready to assess the impact on their operations and financial statements.
Key factors that will help determine U.S. company exposure include sensitivity to any of the following:
- The health of the UK economy
- Your business is highly sensitive to financial market returns, currently volatility, and ratings changes in the UK
- Your investments, budgets, and operating plans are highly sensitive to the health of the UK economy
- You rely heavily on UK/EU customers and distributors from top-line growth
- Your company is owned by or receives investments from UK-based businesses
- The tax, regulatory, and legislative landscape in the UK
- You have material investments and obligations in UK-based operations, leases, projects, defined benefits, inventory, and real estate
- You are using the UK or a UK-based intermediate holding company as a gateway to the EU market
- How goods and services move between the UK and the EU
- You rely on UK and EU-based suppliers and production operations
- Your products, operations, and/or trade areas are subject to local EU regulations
- Free movement of people between UK and the EU
- Your business relies on free movement of people between the UK and EU
- UK talent is essential to your strategy and profitability
The forecast isn’t all doom and gloom however. A new Prime Minister (Theresa May) has taken office, much faster than originally anticipated, thus settling some of the initial political upheaval. Most believe that Prime Minister May will take a “softer” approach to Brexit negotiations than some of her running mates may have, a belief that appears to have stemmed some of the panic which lead to recent volatility. Prime Minister May recently announced a plan to begin the formal process of invoking Article 50 of the Lisbon Treaty, the mechanism by which a member state withdraws from the union, by the end of March 2017. Once triggered, there is a two year negotiation period (unless all EU countries agree to extend it).
On the tax front, can we assess now what taxes will change?
The areas most likely to change are VAT and customs duties. Customs duties law must change, at least formally, because the UK currently has none of its own legislation, but relies on EU Directives and Regulations, which will cease to have effect. VAT would also change because intra-EU supplies of goods and services are treated differently from supplies of goods and services to and from the EU.
It is hard to evaluate precisely what changes are likely to be made until it is known what path the UK will follow in its future relationship with the EU as each path will have different implications as to what EU law the UK is obliged to follow. The possible paths are most likely to be:
- UK joins the EEA (European Economic Area) - like Norway, Iceland and Liechtenstein, the UK would have access to the Single Market and avoid tariffs and customs duties on intra-EEA trade. But the UK would still have many key obligations of EU Membership including financial obligations and adherence to free movement of people which is one of the reasons for the Brexit vote.
- UK signs a bilateral agreement - this would involve more limited access to the Single Market, and would not guarantee a Customs Union and freedom from tariffs. Again, there is likely to be free movement of persons, and compliance issues with many EU obligations, including obligations to contribute to the EU.
- Free Trade Agreement - like Canada. This would bring less access to the Single Market, and tariffs are likely to apply.
It would be best if the UK signs one single agreement with the EU, rather than have separate agreements with each EU member state.
VAT implications of movements of goods between UK and EU
- Currently, the movement of goods between businesses to and from the UK and the rest of the EU (B2B transactions) is without VAT cash flow cost.
- Conversely, currently VAT is accounted for on business to consumer (B2C) sales by the supplier in its jurisdiction, or in the customer’s jurisdiction under the distance selling rules over certain thresholds. The EU Commission as part of the VAT Action Plan has proposed to simplify the distance selling rules by bringing them within the Mini One Stop Shop allowing for electronic accounting of VAT in different member states, obviating the need for EU businesses to register for VAT in each member state where it has customers.
- Following the UK’s exit from the EU, the acquisition rules and distance selling rules will no longer apply to movement of goods to and from the UK. Instead, movements of goods to and from the UK will be treated as imports and exports with different and generally more complex compliance obligations. The “importer of record”, be it the supplier or the acquirer, or freight agent, will have the VAT obligations in the jurisdiction of arrival of the goods.
How will Brexit affect corporate taxation?
- Direct tax is not likely to be so affected by Brexit, as direct taxes are governed by UK law. The laws enacted by the UK must comply with the EU Treaties, and Court of Justice case law relevant to them. The EU Treaties authorize the EU Council to issue directives, regulations and provisions which affect the establishment and functioning of the internal market. These Directives, which need unanimous acceptance, have been implemented by the UK and other Member States - examples include:
- Parent Subsidiary Directive would no longer apply - this eliminates withholding taxes on dividends paid by subsidiaries to parents within the EU, where there is a commitment to a 12 month (or 24 month) holding period and a 10% shareholding.
- Interest and Royalties Directive would no longer apply- this eliminates withholding taxes on certain interest and royalties paid within the EU.
In any event, many of the changes made by the UK to comply with EU law have been business friendly measures which have supported the UK’s position as a leading and business friendly holding company regime, and the UK will be very wary of reversing them. The Merger Directive is a good example, which is implemented into UK law.
- Potentially, UK withholding tax (20%) on UK interest and royalties becomes an issue, once the UK withdraws from the EU and the Interest and Royalty Directive ceases to apply. However, the UK’s wide network of double tax treaties will apply in the same manner as the Directives to remove withholding tax. The terms of the double tax treaties between the UK and each country will need to be reviewed.
- All that said, if the UK were to join the EEA then it would continue to be subject to the EU Treaties and enjoy the benefit of the EU fundamental freedoms. If the UK does not become part of the EEA, it is still unlikely that 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 (assuming the tax systems of EU member states do not discriminate against UK businesses).
All said, the specifics of the exit negotiations probably won’t be known for years, so it’s important to think of the time horizon and the potential implications that doing business in the UK may face at each stage:
- Near Term (2016): financial volatility
- Medium term (2017-2018): drags on US exports to the UK, and regulatory change
- Longer term (2019 and beyond): all companies keep watch, what lies ahead is unclear
If you have any questions about this article contact Stuart Lyons or your BNN tax advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.