This article does not seek to make a case for or against EU membership; rather we aim to set out the potential tax implications of remaining in, or leaving, the EU. This requires a fair amount of crystal ball gazing but there are clear areas where tax issues could emerge.
What if we remain?
Although there would be more potential tax impacts from leaving the EU, it should not be overlooked that the tax environment within the EU is already changing rapidly. The OECD’s anti-BEPS project is driving this change. While the UK was one of the earliest adopters, the EU has also been an enthusiastic supporter and, in the long run, may seek deeper changes than the UK Government originally envisaged.
The EU recently published its own draft anti-avoidance directive see EU moves to reinforce BEPS . It goes further than the OECD Action points in many areas – particularly on using exit taxes to prevent avoidance. Implementing the directive will require the unanimous agreement of member states. Concerns over ‘gold plating’ are expected to mean that this will take a long time and that the directive will look very different when finally implemented.
The key element of both the OECD and EU proposals is that common rules are adopted by all countries so that no tax advantage can be obtained by artificial shifting of profits or activities to other jurisdictions. As a further anti-avoidance measure, the EU is reviving its proposal to create a common consolidated corporate tax base (CCCTB) see Does BEPS make a CCCTB more likely?
One set of corporate tax rules throughout the EU, albeit with different corporate tax rates, would certainly make it easier for companies to do business within the EU. And if EU member states adopt BEPS Actions in a standard way, they will end up with similar corporate tax regimes anyway. So would adopting a CCCTB still be seen as giving up too much political sovereignty if there is an overwhelming vote for the UK to remain in the EU?
What if we leave?
There are so many potential tax implications and variables, depending on the way that a Brexit and ongoing trade deals are negotiated, that it is only practical to give an overview at this stage – but there are positive as well as negative tax implications to consider.
Overview of the cons
It is widely recognised that the chief downside to leaving the EU is the uncertainty that will arise while the UK Government is negotiating both the exit terms and the terms of continuing trade arrangements with the UK. While two years are formally allowed for such negotiations the process could take much longer. Companies will have to consider if this uncertainty gives rise to a ‘principal risk’ that needs to be included in the strategic report with their annual accounts.
Customs duty impact
The most immediate issue would be that the UK would no longer be part of EU’s Customs Union. As a result, EU’s customs duties would apply to imports from the UK, making it less attractive for EU companies and consumers to source goods from UK companies. Similarly, the UK Government may extend the current UK customs duty tariff to imports from the EU, adding costs for UK companies reliant on raw material and finished goods from EU suppliers.
Secondly, the UK would no longer benefit from 34 existing free trade agreements that the EU has negotiated throughout the world. A Brexit would also give rise to non-tariff barriers as all goods would need to be customs cleared (first exported, then imported, in both directions), adding time, complexity and cost to UK companies’ value chains.
The UK would no longer be obliged to have a VAT system after a Brexit but it’s fairly safe to assume that VAT will not be abolished. However, after a Brexit, sales of goods to and from the UK may no longer be able to use the EU’s acquisition and dispatch system, which allows VAT on EU goods to be accounted for on VAT returns. Instead, these would become imports and exports which would need to clear customs and incur import charges on entering the UK or arrival in an EU country. UK importers/exporters would face a cash flow disadvantage due to the delay between payment of customs charges on entry and entitlement to recover the VAT as input tax on the next VAT return. UK businesses would have to consider using deferment and customs warehousing arrangements to mitigate the impact.
UK businesses that are required to register for VAT in an EU member state, eg because they hold stock there or are excluded from the triangulation system as a result of leaving the EU, could face additional administration and costs because many member states require a non-EU VAT registrant to appoint a fiscal representative locally to deal with its tax affairs.
Corporate tax concerns
Withholding taxes are a common feature of many regimes. A UK company that invests overseas may suffer withholding taxes on dividends it receives from its subsidiaries or on royalties received from overseas. If the withholding tax is not eliminated by a tax treaty, then for payments within the EU, the group could rely on the EU Parent-Subsidiary directive or the EU Interest and Royalties directive to prevent the withholding tax being a cost. If the UK is outside the EU then this additional layer of protection would no longer be available.
In recent years, a number of groups have relied on relieving provisions in the UK legislation which prevent a tax charge from being triggered by a cross-border merger or restructuring within the EU. This could be, for example, where a UK business is transferred to an EU entity in exchange for shares. However, the way that some of this legislation has been implemented in the UK may mean that groups could no longer rely on these provisions if the UK were to leave the EU.
A new deal
The terms of any post-Brexit trade agreements that are struck will have a big impact on the tax implications. If the UK joined the European Free Trade Area (EFTA) it would retain access to the European Economic Area and the customs agreements that EFTA has with the EU would mean that any exports to the EU originating in the UK would still be tariff-free. Even so, tariffs would be imposed on imports from other countries passing through the UK before reaching the EU.
Alternatively, the UK Government may be able to negotiate some form of free trade agreement with the EU but such negotiations commonly take years to finalise - the EU-India negotiations were launched in 2007 and are still far from being concluded.
Overview of the pros
Flexibility of Government actions is the most obvious upside of leaving the EU and, while this may lead to many tax implications, it should be remembered that flexibility usually comes with costs attached. For example, if the UK joined EFTA for the customs duty advantages, it would still have to comply with the decisions of the EFTA Court and the four fundamental freedoms enshrined in EU law.
Domestically, the UK’s VAT system would no longer be constrained by EU VAT directives or CJEU case law. The UK could be free to set its own VAT rates and decide which goods or services are eligible for reduced rates and exemptions. While major changes to such a valuable revenue stream are unlikely, there will be lobbying to expand the number of items that can benefit from reduced or zero-rates of VAT. The current obligation to file Intrastat declarations and EC Sales Lists would disappear but businesses would no longer be able to rely on EU law to protect them from HMRC’s policy on VAT treatment of particular supplies.
New tax incentives
Without EU state aid rules to consider, there would be more freedom for the UK to implement innovative measures to attract inward investment. In EIS and the VCT schemes, it is the tax-advantaged investment in the target companies which constitutes approved state aid. Recent EU restrictions have limited the amount of investment that can be raised to £5m in a 12 month period (with a £12m lifetime limit) and reduced the age of a company that can qualify for EIS and VCT relief to seven years. Some of the restrictions have been problematic for growing companies but a Brexit would make it possible to increase the size and age limits and reduce the uncertainty that often arises over state aid approval.
At present, certain tax-advantaged employee share schemes are limited by EU state aid legislation. So, in theory, if the UK leaves the EU some arrangements, such as EMI, could be expanded and extended. However, improving shares scheme tax breaks would represent a fiscal cost, so it remains to be seen if the Government would choose to make radical changes to incentives that are already seen as fit for purpose.
Most government grants are classified as state aid under EU law. This can either be notified or non-notified state aid: R&D tax credits under the more beneficial SME scheme are classed as notified state aid. As a general rule, a company can have access to only one form of notified state aid so receipt of a notified state aid grant will preclude a claim to the SME R&D relief, and vice versa. Therefore, currently it can be necessary to consider which form of aid is the most beneficial to a business when making claims – adding to the complexities that already arise on the interaction of grants and R&D claims. Outside the EU, the UK Government could enhance the R&D reliefs and give both grants and SME R&D tax credits to the same company to encourage growth and innovation.
Other attractive options could include, for example, regional corporate tax rate reductions to encourage business to invest in particular areas. When this was first considered for Northern Ireland, one of the key issues was the interaction with EU rules which required the region to bear the economic consequences of the reduction in local corporate tax receipts.
The flexibility to offer such incentives without state aid restrictions would still come at a cost after a Brexit. EFTA members must abide by state aid rules – so the UK could avoid them by not joining EFTA , but then UK importers and exporters would face a tougher customs duty regime for trade with the EU.
After a vote for Brexit, the UK Government may see the need for urgent action, perhaps in an emergency Budget, to protect levels of foreign direct investment. Tax changes to attract entrepreneurs, such as cutting the top rate of income tax to 40% and capital gains tax exemptions for inbound investors, might be considered. Advancing the planned cuts to corporation tax rates would both encourage inbound investment by multinational groups with an existing UK presence and act as an incentive for businesses to stay in the UK. There may also be more flexibility over the introduction of some of the anti-BEPS measures. However, to date, the UK Government has been an enthusiastic proponent of such changes and it is not clear that it would want to delay implementation.
Whatever the result of the EU referendum, it is vital that the UK Government delivers policies that promote export and international trade and play to the UK’s historical strengths as a trading nation.
Read BDO’s recommendations for building the New Economy.
See the results of our survey BREXIT: What do UK mid-sized companies want?
Business Edge 2016 index
Visit our Brexit hub