How hard is a hard Brexit?

With Article 50 triggered and negotiations for the UK’s exit from the European Union well and truly underway, businesses are aware that they need to plan for all eventualities. But some are still asking “how hard is a hard Brexit?”

The expected focus on drawing up a “divorce” agreement has led many experts to believe that trade deals are unlikely to be forged quickly. But what happens if they aren’t and are businesses ready?

Trade agreements

Trading relationships between different countries are defined by trade agreements and the UK currently has three in place – the single market, customs union and World Trade Organisation (WTO) agreements.

Prime minister Theresa May has already ruled out the possibility of the UK remaining in the single market post-Brexit, which currently allows for the free movement of goods, services, people and capital within the EU. So, it seems likely that businesses will become subject to greater administrative and regulatory barriers when trading in goods and services with the EU. For example, goods exported from the UK to the EU are likely to be subject to increased customs checks at the EU border.

It remains to be seen whether the UK’s membership of the customs union will continue. This allows goods to be moved within the customs union, which includes all EU member states plus a few other countries, without payment of customs duties, known as “tariffs”. If the UK leaves the customs union, there will be two options.

Negotiating a new deal

The first option is to negotiate a new trade agreement with the EU. The negotiations would be hugely complex and the prospect of securing a trade agreement with the EU before Brexit in early 2019 seems remote. For example, the trade agreement between the EU and Canada (Comprehensive Economic and Trade Agreement, or “CETA”) took seven years to be agreed. The US and the EU have failed to reach agreement concerning the Transatlantic Trade and Investment Partnership (TTIP), after three years of negotiations. So, the precedents are stacked against a quick deal being done between the UK and the remaining 27 EU member states.

WTO rules

The alternative is for the UK to rely on its membership of the WTO, until new trade agreements can be put in place. The UK and most other major trading nations are members of the WTO, including all EU member states, albeit they act as a single WTO member.

The purpose of the WTO, as with any trade agreement, is to facilitate trade between its members and to eliminate trade discrimination. The WTO sets the maximum rate of customs duty that members can apply to importations of each classification of goods. Members are free to apply lower rates of duty if they wish, but they must offer the lower rates to all members.

One option is for the UK to apply the WTO rules and to reduce the WTO rates of customs duty to mirror those currently applied by the EU. This would mean that, as far as the UK’s trade with non-EU countries is concerned, there would be no change to the rates of customs duty applied to goods imported into the UK. However, it would mean that goods imported into the UK from the EU would be subject to customs duties (and vice versa), whereas they are currently duty free.

The average rate of customs duty applied to goods imported into the EU is approximately 5%. This figure is an average, with some goods being subject to much lower (nil in some cases) or higher rates of customs duties. For example, the EU has a 10% rate of customs duty for cars, however, there are preferential rates for certain countries.

Impact

Clearly, the imposition of customs duties on goods exported from the UK to the EU could make UK businesses less price competitive, as the customs duties payable would have to be built into the price of the goods. Customs duties on goods imported into the UK from the EU could mean higher prices for UK consumers.

A hard Brexit under the WTO rules could, therefore, have an impact on the UK’s economy. However, it is worth remembering that international trade in goods makes up a relatively small proportion of the UK’s output and, therefore, the impact of Brexit on the services sector may be a higher priority for the government, at least in the short to medium term.

So, what now?

At this stage, it is impossible to predict the outcome of the UK’s Brexit negotiations. However, given the huge complexity of this task, it seems quite possible that customs duties will be imposed on goods traded between the UK and EU whilst a UK-EU trade agreement is concluded.

One thing that is clear is that the government is going to find negotiating a Brexit challenging.

Businesses involved in the EU trade of goods should keep a close eye on how the negotiations progress, the impact it will have on the ability to compete with EU businesses and the opportunities that it may create with non-EU countries.

Robert Facer is VAT director at accountancy firm, Menzies LLP. He is also a member of the firm’s Brexit Action Team.