Confluence Tax offers a technical briefing on the UK’s impending EU exit and the potential tax implications for tech and biotech companies
ALTHOUGH tax is just one of a raft of implications of Brexit, as an investment driver it will become relevant to consider what the tax implications will be and the potential outcomes.
It is rare to find a company with no international dimension, no cross-border transactions or international employees or investors. Even for companies with no direct ties to the EU, the UK tax system is likely to develop differently once EU membership constraints no longer apply.
Options for exit
Timing of the UK’s exit is unknown, as is the shape of any new relationship with the EU. A full exit, where the UK is no longer bound by any EU legislation, will differ significantly from a deal where the UK agrees to be bound by EU rules in order to receive benefits such as access to the single market and R&D award schemes, such as Horizon 2020.
VAT is an EU tax. Harmonised VAT rules are fundamental to a single market and the system used in the UK is, accordingly, the same as that across the EU member states, governed by the same principles and a large body of case law.
Full exit from the EU would leave the UK free to amend VAT rates and policy at its discretion. The various simplification mechanisms for operating throughout the EU would, presumably, not be available and this, together with eventual differences, would likely complicate how a business deals with its VAT position. A deal that includes access to the single market would likely lead to continued commonality between UK and EU tax systems.
The EU does not have jurisdiction over direct taxation; however, the EU fundamental freedoms – as interpreted by the European Court of Justice – have had a huge impact on UK direct tax legislation. Change here will not be immediate, but it could be more significant in the long term.
EU directives have directly impacted UK tax legislation, for example the Mergers Directive and the Interest and Royalties Directive.
The concept of non-discrimination has meant that UK law must not treat UK and EU/EEA companies differently. Challenges by taxpayers to the European Court have resulted in key changes to UK legislation; for example, the amendment of the grouping rules to permit non-UK entities and the introduction of limited cross-border loss relief. The same concept has led to – arguably – overly restrictive anti-avoidance legislation, such as UK-UK transfer pricing and implications of nexus (between R&D expenses and patent income) for patent box benefits.
Although the current international project influencing tax avoidance provisions (BEPS) is distinct from EU membership, an exit from the EU may give the UK more flexibility in how BEPS recommendations are implemented.
It is also necessary to consider the implications for capital transactions with EU and EEA territories and how the tax treatment in jurisdictions other than the UK will be impacted. If the concept of free movement of capital no longer applies to the UK, transactions and investment between the UK and the EU/EEA may increase in cost and complexity.
While still a member of the EU, the UK is constrained by EU state aid rules. These rules mean the state cannot provide incentives for particular tax payers or groups unless provided for under EU rules.
Thus, the amount of R&D credits has been restricted by the aid permitted by the EU. The rules around credits are also restricted by EU definitions, such as the definition of an SME. Similarly, investment incentives, such as EIS, are restricted by the EU provisions.
Exit from the EU also opens up the possibility of reliefs targeted at certain industries and taxpayers. An example is capital allowances specific to a particular industry. Again, any eventual arrangements made with the EU may require the UK to abide by state aid rules, meaning that such flexibility does not materialise.
Withholding taxes and tax treaties
The UK has a strong network of double tax treaties, including treaties with all other EU member states. Many of the treaties allow for no withholding taxes, but this is not the position in every case. On exit from the EU, the Parent and Subsidiary Directive and the Interest and Royalties Directive may cease to apply, such that withholding taxes could be imposed.
One indirect consequence of the exit may be to alter the treaty position of transactions that are not even with the UK. For example, there may be issues with limitation of benefit clauses that rely on an equivalent beneficiary definition dependant on EU membership.
Personal taxes, management incentives
International employees in the UK will continue to be able to rely on double tax treaties. It is possible that the concepts of free movement of people and non-discrimination will form part of any ultimate agreement, meaning that the position of employees is preserved.
Customs duties will be a key area for negotiation for the UK. If the UK is no longer constrained by the free movement of capital requirements this could have implications for stamp duties and could open up the possibility of other taxes on capital.
It is very much business as usual in the short term; the UK is still a member of the EU and will remain so for at least two years.
In the longer term, the position for taxes in the UK remains uncertain and the final outcome will depend on the terms of exit that are finally agreed after Article 50 is triggered. Going forward there is potential for fundamental changes that could give a flexible and competitive tax system, well placed to attract investment.
Colin Hailey, April 2016
“There are no immediate tax changes or actions as a result of the Brexit vote. Moreover, we shouldn’t expect sweeping changes to the tax regime in the short to medium-term as a result of Brexit.
“The longer-term tax implications for knowledge-intensive companies and investors could be positive following Brexit, with more targeted tax incentives for the UK market, without EU state aid restrictions. We hope there will an informed and careful transition to any such new UK schemes, to compensate for the loss of any EU grant regimes.” – Colin Hailey