David Cameron, in agreeing a reform package at the EU Summit, announced that there will be a referendum on Britain's membership of the European Union on 23 June. Tax Partner, Roopa Aitken, looks at the possible tax implications of a vote to leave the EU.
The implications of a vote to leave are largely dependent on what alternatives the UK is able to negotiate. If the UK were forced to re-negotiate various agreements from scratch and alone, it could take many years.
This delay would create a period of uncertainty and could mean businesses would be faced with the potential loss of free movement of goods with the EU. This would increase both cashflow (no relief for import VAT) and real costs (duties). In addition, there may be barriers when exporting to the EU, not only fiscal but increased administrative burdens too.
In practice, there will be a period of time immediately following any vote to leave, during which the withdrawal terms are agreed between the UK and the EU. In the interim this could allow time to renegotiate its position going forward and therefore not leave businesses as exposed.
Potential trade solutions
As the EU is the UK's biggest export market, the UK will presumably want to negotiate a new trading relationship with the EU to allow UK companies to sell goods without excessive customs tariffs. Two often cited examples the UK could look to follow are:
- Norwegian model – the relatively quick option would be for the UK to adopt the Norwegian model and join the European Free Trade Association (EFTA) which the UK was a part of before it joined the EU. This would allow it to participate in the internal market.
- Swiss model – this involves negotiating bilateral agreements with the EU to gain access to the single market. However, this option could take many years – it took the Swiss ten years to negotiate and implement!
Direct tax implications
Although the setting of direct tax matters remains within the competency of each Member State, they must have regard to the EU fundamental freedoms i.e. that the tax rules should not hinder the free movement of goods, capital, people/businesses and services.
These provisions are incorporated in the UK by virtue of the European Communities Act. If the Government repealed this Act, requirements such as ensuring the fundamental freedoms were adhered to would fall away.
However, there are many areas of UK tax law which have incorporated legislation based on these principles, such as the UK group relief rules. These have become a part of UK law and so repealing the Act will not make the parts incorporated into UK tax law redundant. Should the UK wish to amend any of these rules post exit it is likely that this will be done on a piecemeal basis over time. However, should the UK join EFTA, the same fundamental freedoms would continue to apply.
Continuing with direct tax matters, there are a number of EU Directives which provide for reduced tax burdens within the internal market. For example the Parent/Subsidiary Directive, inter alia, exempts dividends paid by an EU subsidiary to its EU parent from withholding tax while the Interest and Royalties Directive eliminates withholding taxes on interest and royalty payments between EU related group companies.
If the UK were to leave the EU it would no longer be able to benefit from these reduced withholding taxes. This could be a real cost, for example, a UK parent company may well find itself subject to dividend withholding tax on a dividend received from an EU subsidiary. Because such dividends are usually exempt from tax in the UK there would be no way of getting relief for the additional foreign tax suffered and it would be an absolute cost.
Again Switzerland (although not the EFTA countries) has entered an agreement with the EU to provide equivalent benefits to Swiss companies and it would seem likely that the UK would seek to do the same.
Indirect tax implications
Exiting the EU could eliminate the cross-border personal shopping allowances for duty paid excise goods, replacing it with a much smaller duty-free allowance for travellers, most likely similar to non-EU travellers.
Given the UK's current concerns about tax leakage through the abuse of this allowances, eliminating it may be welcome, but would almost certainly require the support of an increased physical presence at the border. Many UK producers and distributors of alcohol and tobacco generate significant revenue from the cross border shopping market, which would be eliminated by Brexit.
Value Added Tax (VAT)
Of course, VAT is a European Tax and so currently the UK's VAT legislation must be directly in line with the EU Principal VAT Directive (PVD). EU tax payers are able to rely on EU law and European Court rulings must be adhered to. But if the UK chooses to leave, we can only suspect that the old rulings will no longer continue to be binding.
This could also be true for the restrictions set out in the PVD, for example on VAT rates and exemptions. Following Brexit, UK VAT registered businesses will no longer have the clarity they currently have on levels and scope of Indirect Taxation. They will not benefit from principles and freedoms of EU law afforded to all EU residents, such as fiscal neutrality, equality, and proportionality.
Pick 'n' mix tax
If the UK seeks to negotiate the tax rules with the EU (post exit) it may be able to cherry pick so that it does not have to be subject to those it does not want. While Brexit offers apparent opportunities to remove unwanted taxes and legislation, it is unlikely that the EU will allow any new agreements to be completely one sided.
The tax implications of the UK leaving the EU will depend on what other agreements the UK is able to negotiate post exit. In the longer term it would seem likely that the UK will want to be able to access some of the same tax advantages it has now e.g. with respect to withholdings taxes, duties and VAT (without potentially some of the administrative burdens).
It may be therefore that the tax position ends up similar to current arrangements. How it goes about achieving this e.g. whether on its own or by using its relations with a wider collective such as EFTA could impact on the speed with which any new rules can be negotiated and implemented.
While the uncertainty created during any transitional period will be disruptive for businesses, Government can help alleviate this through providing guidance on timeframes and roadmaps for future legislation.
Read our guidance on Brexit and explore how we can help
Exploring potential changes to trade and supply chains
Retaining and recruiting the skills you need through Brexit
Exploring the key issues around finance and business infrastructure