How Brexit will change the UK tax environment

Phillip Gershuny, senior tax partner at Hogan Lovells, outlines how a European exit could affect UK taxes

THERE ARE many uncertainties surrounding Brexit.

The pending result of the EU referendum forces several questions into the minds of British citizens everywhere – if the UK votes ‘no’ to being in the EU, on what basis will it leave the EU?

Will it remain in the European Economic Area (EEA) like Norway, join the European Free Trade Association (EFTA) like Switzerland or have a completely different relationship with the EU?

What is certain however is that leaving the EU has the potential to change the tax environment in the UK.

What will change if Brexit becomes a reality?

The UK tax implications of Brexit are difficult to predict, not least because the terms of any future exit are, as yet, unclear.

However, we can say that unless the UK enters into comparable arrangements with other EU member states exiting the EU, it could mean that UK firms cease to be able to benefit from tax advantages currently available as a result of the EU’s fundamental freedoms – for example, those provided by the Parent-Subsidiary directive, the Merger directive and the Capital Duty directive.

Although in some cases, it could provide certain benefits. A UK government unconstrained by EU state aid rules and fundamental freedoms could provide UK businesses with more favourable tax treatment than that provided to other businesses.

Value Added Tax

If the UK leaves the EU, it will no longer be required to give effect to the VAT directive and so will no longer have to require UK businesses to charge and pay VAT on domestic supplies of goods and services.

However, as VAT constitutes a large proportion of the UK Government’s annual tax revenue – 22% in 2014 and 2015 – it is unlikely that the UK Government would repeal it without replacing it with a new UK sales tax.

A UK government unconstrained by the VAT directive would have more flexibility as to the rate of a new UK sales tax and could, for example, set its own rates and determine the types of goods and services subject to each rate.

Even if it wished to, it is unlikely that the UK government could apply the current VAT rules to a UK sales tax without modification. There is therefore a question about the extent of such modification. Would any UK sales tax mirror VAT as closely as possible, both at the time it came into force and in the future; or would it mirror VAT as closely as possible on introduction but not reflect future changes to EU law.

Parent-Subsidiary directive

If the UK leaves the EU, it will no longer be required to give effect to the Parent-Subsidiary directive.

Broadly, this provides that where a parent company in one EU Member State receives distributions of profits from a subsidiary company in another EU Member State, the EU Member State of the parent company must not tax the receipt or, if it does (in certain circumstances in the case of the UK), must allow the parent company credit for tax paid by the subsidiary company in respect of the profits distributed.

If the UK leaves the EU and so the Parent-Subsidiary directive no longer applies, a group of companies with a parent company in the UK and subsidiaries in an EU Member State or a parent company in an EU Member State and subsidiaries in the UK may become subject to double taxation in respect of profit distributions, unless a double tax treaty or similar arrangement prevents such double taxation.

In fact the UK is one of the jurisdictions that have concluded the greatest number of double taxation agreements including with all current members of the EU. Some treaties however do not wholly relieve withholding tax on payments of dividends by subsidiaries to their UK parents (e.g. the payment of dividends by German subsidiaries to UK parents).

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What may change if Britain leaves the EU?

State aid

If the UK leaves the EU (assuming it is no longer part of the EEA and does not join EFTA or enter into similar arrangements with the EU), it will no longer be subject to EU law restrictions when seeking to grant State aid.

The corollary of that, however, is that it will no longer have any recourse through the EU against EU member states introducing State aid that disadvantages UK businesses.

Capital Duties directive

If the UK leaves the EU, it will no longer be required to give effect to the Capital Duties directive. Broadly, this prevents EU member states from charging indirect tax in respect of the raising of capital by companies (for example, by issuing shares or other securities) in certain circumstances.

UK legislation currently imposes a 1.5% Stamp Duty Reserve Tax (SDRT) charge on issues of shares and securities to depositary receipt issuers and clearance services in certain circumstances.

However, as a result of the Capital Duties directive, and decisions of the CJEU and first-tier tax tribunal, HMRC announced it would no longer seek to impose such a charge. If the UK were no longer in the EU, assuming it does not enter into similar arrangements with EU member states, the UK government would be free to impose this SDRT charge. If it wished, it could also impose a new capital duty.

Other areas of incompatibility with EU law

If the UK leaves the EU (without entering into similar arrangements), it will no longer be required to ensure its tax legislation is compatible with EU law.

In the past, the Court of Justice of the European Union (CJEU) has declared UK tax legislation to be incompatible with EU law and required such legislation to be amended.

For example, in HMRC v Philips Electronics UK, the CJEU held that the UK consortium relief rules, which denied relief for UK losses of non-UK resident companies carrying on a trade in the UK through a permanent establishment if it was possible for the loss to be relieved overseas, were contrary to the freedom of establishment. Following Brexit, UK tax legislation will no longer be open to challenge on the basis that it is contrary to EU law.

Phillip Gershuny is a senior tax partner at international law firm Hogan Lovells

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