2016-Issue 22 – The referendum in the United Kingdom on whether to leave the European Union has produced a clear, if close, result in favor of leaving. In this edition of Tax Advisor Weekly, we consider the immediate impact of the result, the potential impact on the tax system in the United Kingdom and internationally, and the likely response from business.

Immediate Reaction
The immediate reaction in the United Kingdom and across Europe has been one of shock, as few in business or politics predicted this result. There has been major political upheaval, and financial markets have been volatile, although the London stock market has largely recovered its initial losses. The British pound has sunk against both the dollar and the euro. The United Kingdom’s credit rating has been downgraded by all three credit rating agencies.

The general view is that major business decisions and transactional activity across all markets will remain subdued until the position becomes clearer. The exchange rate move will help U.K. exporters and make U.K. assets look cheap to potential investors, although this must be balanced against the fact that the cost base of many U.K. businesses has increased.

Timetable
The result of the referendum is technically only advisory. It does not in itself trigger a process of leaving, although the government has said it will abide by the result. The process of leaving starts only when the U.K. government invokes Article 50 of the Lisbon Treaty, which then provides for a two-year period in which the terms for exit are to be agreed. The two-year period can be extended by agreement with all EU states.

Following the resignation of the Prime Minister, David Cameron, there is a new Conservative leader and Prime Minister, Theresa May. She has indicated she will not trigger Article 50 until the negotiating landscape looks clearer and, in any event, not before the start of 2017. There is disagreement between the EU Commission and some member states as to the extent to which informal discussions can take place ahead of triggering Article 50, but it is expected that some such discussions will take place, and the U.K. government will publish its intended negotiating position towards the end of the year. This will form the basis of extended negotiations during the two-year period after Article 50 is triggered, with many predicting that the negotiations will actually go on much longer than this. There is therefore no certainty at this stage as to when the United Kingdom will leave the EU and what the terms of that exit might look like. In the meantime, the United Kingdom will remain an EU member and EU laws will continue to apply.

Tax Changes
No immediate tax changes have occurred as a direct result of the vote. Even when the United Kingdom leaves the EU, there are relatively few changes that will happen as a direct result, but the United Kingdom may have additional freedom to amend its tax system. This is some years away and will depend on a number of factors, including the terms of any trade agreement that the United Kingdom negotiates with the EU. The current base erosion and profit shifting (BEPS) agenda on international taxation is unlikely to change significantly, whatever the result of these negotiations.

As a result of leaving the EU, the United Kingdom will no longer be bound to comply with European law or be subject to the jurisdiction of the European Court of Justice. This is most relevant to the VAT and indirect tax regimes, but it has also been a constraint on other tax lawmaking. The removal of the EU’s state aid rules will no longer prevent the United Kingdom from discriminating in favor of domestic businesses or certain industries, although there is no indication of any current intention to do this.

Corporate Taxation
The United Kingdom largely has control of its own corporate tax regime already and will not need to change it following Brexit. The tax regime remains an attractive one for both inward investment and for regional headquarter operations. The corporate tax rate is due to reduce to 17 percent by 2020 and may come down further in the light of the Brexit position. There is a participation exemption for most foreign dividends and also for share disposals of trading subsidiaries. The latter is being reviewed at the moment and is likely to be extended to a wider range of transactions. The United Kingdom also has an extensive network of double tax treaties with typically low or nil withholding taxes on dividends, interest and royalties.

Following Brexit, EU directives may no longer apply to the United Kingdom. These include the EU Parent-Subsidiary Directive, which prohibits withholding tax on dividends in many cases. The United Kingdom’s treaty network will provide equivalent protection in most situations, but there are one or two treaties, in particular, those with Italy and Germany, that do not reduce the withholding tax rate to nil on dividends paid to the United Kingdom. Some reorganization of existing international structures may be required as a result.

A related point here arises in other countries. Some EU jurisdictions rely more directly on EU law, rather than incorporating it into their own laws. For example, while the United Kingdom has its own rules on merger reliefs, other countries may rely directly on the EU Mergers Directive to effect a tax-free corporate reorganization involving a U.K. company. In some future cases, such relief may no longer be available, and in others there may be a tax clawback if the United Kingdom ceases to be a member of the EU within a certain period following the transaction.

More generally, the corporate tax agenda is largely being driven at present by the OECD and wider international initiatives such as BEPS. This is unlikely to change following Brexit, as the United Kingdom remains a G20 member and continues to push ahead with early adoption of the BEPS initiatives.

Otherwise, the main difference is likely to be the absence of EU law as a constraint on what the government is able to legislate for and as a means of challenging existing tax law. For example, currently tax law in the United Kingdom must be careful not to discriminate against EU businesses, so that U.K.-U.K. transactions are usually treated in the same way as U.K.-EU transactions. These constraints will be removed.

Customs Duties
A key concern for business is whether tariff barriers will go up if the United Kingdom leaves the EU customs union. This depends on the exit terms agreed. However, even without agreement, the United Kingdom is a member of the World Trade Organization, and current WTO tariffs are only around 4 percent. The decline of the currency has already more than countered the effect of this for U.K. exporters.

There are a number of options for terms of exit. Much will depend on which option is agreed upon. Some of the possible outcomes are:

• The United Kingdom agrees to stay part of the European Economic Area (similar to Norway). It will then stay largely within the single market and the tariff-free zone. However, as this would probably entail committing to most existing EU regulations, including free movement of people, it is seen as relatively unlikely.
• The United Kingdom agrees to a trade agreement or series of agreements with the EU removing most or all trade barriers, and perhaps also continues the passporting system for financial services. It is likely that any such agreement would still require the United Kingdom to continue to comply with some EU rules, but it is not clear what this might entail.
• The United Kingdom decides to have no agreement and operate on WTO rules. It would then seek trade agreements with other countries such as the United States.

Value Added Tax
The United Kingdom is unlikely to change its VAT system radically, but as it will no longer be bound by the common EU VAT system rules, it may choose over time to introduce additional lower or zero rates for certain supplies of goods and services. It may also have greater latitude in how the detailed rules are framed and applied. There will be consequential changes to the rules and procedures for invoicing and paying VAT on imports and exports, although this is unlikely to result in significant extra or reduced tax charges.

Issues for International Businesses
It is too early to determine how businesses should react to the new situation, given how uncertain the terms of any eventual U.K. exit still are. As the scale of tax change is not expected to be particularly high as a direct result of Brexit, tax is typically not top of the immediate agenda, but corporates need to know what the implications are and what the direction of travel might be.

In the short term, the key issues for businesses that might have tax implications appear to be as follows:

• Currency exchange rates. Businesses are facing extreme uncertainty as well as extra costs. The measures they will take to deal with this include cost-cutting, hedging, relocation of some transactions and paying staff in different currencies. All may have tax implications.
• Recruitment. Until more is known about the immigration position, businesses are being cautious about hiring people in the United Kingdom who might have to work in Europe, and vice versa. It seems likely that existing EU residents in the United Kingdom and U.K. residents in the EU will have their rights preserved, but it is less clear what the position for future movers will be. There may be employment tax and social security issues for moving employees or recruiting in different jurisdictions.
• Structuring / M&A. Where cross-border transactions are still being undertaken or new platforms established, multinational businesses and international funds will want to future proof their existing and new structures to make them flexible for a range of future outcomes. Some multinationals will want to consider moving operations or restructuring to ensure they remain covered by EU single market protections. There will be significant tax issues arising from any such considerations.

Alvarez & Marsal Taxand Says:
The general message is that there is no need to rush any decisions, as the timetable for Brexit is likely to be long and drawn out, and tax changes will be limited in the interim. Any acquisitions or new cross-border structures need to have flexibility built in to cope with the range of possible outcomes. Businesses should be mapping their supply chains of goods and services to see how they might be affected by changes to the U.K.’s tariff and VAT regimes resulting from Brexit.

The political, economic and fiscal landscape is changing fast, and it will be important to keep close track of developments.

Disclaimer
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.

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