5 minute read 19 Apr 2019
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Why firms need a plan in place to address the tax challenges posed by Brexit

EY FS Insights
By EY FS Insights

Minds Made for Financial Services

5 minute read 19 Apr 2019
Related topics Tax Financial Services EMEIA Brexit – Crossing borders in Financial Services
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Brexit will have several impacts on business, including potential implications for regulation, legal, financing, the operating model, foreign exchange and tax.

From a tax perspective, Brexit will give rise to several changes, however, it is also worth highlighting what will remain the same. Subject to any specific future changes to be made by the UK Government, all enacted UK domestic tax legislation will remain in force post-Brexit, including those pieces of law that were originally designed or amended to be compliant with EU law, such as VAT, transfer pricing, and exemptions from withholding tax on interest/dividends.

Minor amendments 

The UK Government will have to address the body of UK tax law that derives definitions, etc., from EU law, e.g., the UK bank levy. However, the current UK Government approach is to maintain the status quo where possible in order to provide as much certainty as possible for taxpayers at a time of significant change. 

Limitation on powers to make minor amendments 

A cross-party amendment to the Finance Bill prevents the Treasury having the right to spend money on no-deal Brexit arrangements (under clause 89 of the Bill). This right is unless:

  • There is a negotiated withdrawal agreement and a framework for the future relationship 
  • The Government has sought an extension of the Article 50 period
  • The House of Commons has approved leaving the European Union without a withdrawal agreement and framework for the future relationship. 

The amendment effectively requires the Government to use other legislative means (rather than via the power in the Finance Bill) to make any necessary tax changes in the event of a no-deal exit where Parliament has not agreed to that outcome.

Value Added Tax (VAT) 

HMRC has released updates to the Specified Supplies Order, the legislation which sets out a business’s rights to recover VAT on financial and insurance services. This legislation will be implemented in the event of a “no-deal” Brexit. 

The changes maintain the status quo, meaning that only supplies to non-EU customers (other than UK customers post-Brexit) will carry a VAT recovery right. VAT will not, therefore, be recoverable on financial and insurance services to UK or EU customers. The change in wording ensures that the UK is not accidentally treated as a non-EU jurisdiction. 

The treatment of financial and insurance services to EU customers has been the subject of a great deal of interest with many lobbying for supplies to EU customers to carry a recovery right. The fact that they will not is likely to be unwelcome and, furthermore, may put UK businesses at a mismatch with EU businesses. This is because, assuming EU VAT law does not also change, supplies from EU business to UK customers will carry a recovery right whereas supplies from the UK to the EU will not.

What would the post-Brexit impact be on UK tax policy?

In a no-deal scenario, the UK Government would be able to set corporate tax policy free of the constraints of EU law, especially EU State Aid rules. However, the Government has already laid a Statutory Instrument (SI) giving the Competition and Markets Authority (CMA) powers to ensure a domestic State Aid regime would be in place in the event of a no-deal scenario. The SI transposes the EU State Aid regime into domestic law and it is intended that there will be no material change to the definition of State Aid or to the general prohibition on giving aid. There are also a number of practical points that may constrain the UK’s freedom of action with regard to UK tax policy:

  • The UK has signed up to all of the Base Erosion and Profit Shifting (BEPS), Action Plans, including Action 5 on harmful tax practices.
  • The UK will presumably, even in the event of a no-deal Brexit, look to agree a free trade agreement (FTA) at some point in the future with the EU, and such a FTA may well include some “level playing field” requirements around tax (amongst other matters).
  • The European Commission has prepared papers setting out proposals for possible counter-measures to take against the UK should the UK engage in what the EU considers to be harmful tax practices.
  • The UK’s approach to tax policy will also be informed by overall fiscal position and what is affordable from an Exchequer perspective.

Where is the greatest potential impact for change from a tax perspective?

Post-Brexit tax impacts include the loss of application of EU fundamental freedoms and taxation Directives with respect to the UK, amongst other things.

EU Directives no longer applying to UK companies 

Post Brexit, the UK will no longer be required to give effect to various EU tax-related directives and this may potentially make the UK a less appealing holding and financing company jurisdiction. Perhaps more importantly, however, UK companies would not post-Brexit be able to rely on such directives. In particular, from a corporate income tax perspective:

  • Parent/Subsidiary Directive (PSD)

    PSD which prevents withholding tax on dividends paid from one EU company to another EU company and double taxation of parent companies on profits of subsidiaries. Thus, post-Brexit, 8 out of the 27 EU Member States (including, currently, Germany and Italy) would impose withholding tax on dividends paid by local companies to a UK company. The UK will be looking to negotiate revised double tax treaty arrangements with (at least some of) these countries to remove such WHT — but the timing and outcome of any such negotiations is not certain.

  • Interest and Royalties Directive (IRD)

    IRD prevents withholding taxes on interest and royalties streams between EU companies. Thus, 5 of the EU27 Member States (including, currently, Italy and Portugal) would, post-Brexit, impose WHT on interest paid by local companies to a UK company. Another potential point arises because of the way in which the IRD has been implemented into UK law. The enabling legislation in sections 757–767 ITTOIA 2005 refers to “companies” as defined in the IRD. This definition applies to a company which “in accordance with the tax laws of a Member State is considered to be resident in that Member State”. As the UK will no longer be a Member State, there is an argument that these sections in ITTOIA no longer have an effect.

  • EU Merger Tax Directive (EMTD)

    EMTD prevents corporate income taxes being crystallized in a few re-structuring situations, such as mergers, divisions, transfers of assets and exchanges of shares concerning companies of different EU Member States. Where any Brexit related re-structuring is looking to the EMTD to remove the risk of tax being crystallized, particularly in any EU branch jurisdictions, it is imperative that such re-structuring is effected before Brexit to ensure that such tax does not arise.

Restricted application of EU Treaty fundamental freedoms and Court of Justice EU case law

Companies (irrespective of whether based in the UK, the EU27 or anywhere else) will post Brexit no longer be able to rely on EU Treaty fundamental freedoms and CJEU case law when considering their tax position in the UK, or in future disputes with HMRC. Their ability to do so with respect to EU27 jurisdictions, and tax authorities in those countries, may also be constrained compared to the current position (such claims would largely be limited to the application of the free movement of capital provisions of the EU Treaty). 

There is also a question as to what impact a no-deal Brexit will have on current disputes with both UK and EU tax authorities that have not yet been determined by a competent court or tribunal.

  • Loss of US double tax treaty benefits for EU subsidiaries

    There may be an impact on the eligibility of European entities that are owned by a UK parent to claim relief under double tax treaties between the relevant EU jurisdiction and the US.

  • Restriction on use of EU Arbitration Convention

    The EU Arbitration Convention establishes a procedure to resolve disputes where double taxation occurs between enterprises of different Member States as a result of an upward adjustment of profits of an enterprise of one Member State. The Convention is an international treaty rather than EU legislation; however, following Brexit, the UK would not be one of the countries listed in Article 52, and would therefore fall outside the territorial scope of the Convention. This is likely to mean that disputes involving the UK arising pre-Brexit would be dealt with pursuant to the terms of the Convention, but disputes involving the UK arising post-Brexit would not. Consequently, there may be merit in looking to accelerate disputes in order to fall within the terms of the Convention.

Priority activities in a no-deal scenario

Given the challenges mentioned above firms should consider the following activities ahead of Day 1:

  • Do you have a plan in place to address the fact that your UK operations, customers and suppliers will no longer be EU established and this may affect access to EU rules including tax directives?
  • Have you assessed how your VAT charges, VAT recovery and other taxes will be impacted by the UK leaving the EU?
  • Are you able to accelerate initiation of any pending litigation with EU/UK tax authorities that are dependent upon EU Directives or CJEU case law?

Summary

Given the challenges mentioned above, firms should have a plan in place to address the fact that UK operations, customers and suppliers will no longer be EU established and this may affect access to EU rules including tax directives. Firms should assess their VAT charges, VAT recovery and other taxes which will be impacted by the UK leaving the EU. Lastly, firms should be able to accelerate initiation of any pending litigation with EU/UK tax authorities that are dependent upon EU Directives or CJEU case law. Download our survey (PDF)

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EY FS Insights
By EY FS Insights

Minds Made for Financial Services

Related topics Tax Financial Services EMEIA Brexit – Crossing borders in Financial Services
Upvote