At 11pm on Friday 29 March 2019, the UK will leave the European Union. The European Union Withdrawal Bill will come into effect, repealing the European Communities Act, 1972; converting all EU legislation over the UK’s 40-year membership into UK law; and granting ministers power to make secondary legislation. We’ll enter a transition period during which the government will review and amend these laws as it sees fit, while businesses will prepare to meet the new compliance requirements before we hit the deadline of midnight on 31 December 2020.
Both Theresa May and Jeremy Corbyn have made it clear that the UK will leave the single market, where members guarantee freedom of movement of goods, capital, services and labour. Instead, the UK will need to establish a new way of trading with EU Member States. Possible alternatives include:
- EEA membership (Norwegian model), granting full Single Market access, with associated obligations.
- A Negotiated Bilateral Agreement (Swiss model), providing limited access to the Single Market.
- An Advance Free Trade Agreement (Canadian model), further reducing access to the Single Market. Such an agreement would require careful negotiation in respect of both goods and services, given the significance of the UK services sector.
- Relying on World Trade Organisation (WTO) membership, providing no access to the Single Market. Instead we presume that the EU would impose tariffs on goods it imports from the UK. Unfortunately, neither financial services nor aviation are covered by the WTO.
In terms of trade, the current position of the UK Government is that the UK will leave the customs union at the end of the transition period, with a comprehensive free trade agreement being touted as the favoured alternative arrangement. What will follow, however, remains open to debate and it’s this ‘unknown’ that is causing no little consternation. We simply don’t yet know how this will impact indirect taxes such as VAT and customs and excise, or the likely effects on direct tax, although we can explore the likely outcomes. What is a given, is that Brexit will dramatically affect how UK businesses handle tax.
Leaving the EU will have a significant impact on both VAT and Customs, both of which are essentially EU taxes. The EU VAT Directives are enshrined in UK VAT law, however, post Brexit, new EU Directives will no longer need to be written into UK VAT law. Also, the UK would potentially need to introduce its own Customs Duty system, although some models would allow the UK to remain in the Customs Union.
Our departure from the single market will have significant repercussions for VAT including:
- Importing goods from within the EU: The UK will become a third country from a VAT perspective when trading with the EU, meaning that VAT will be imposed on cross-border supplies from the EU member states to the UK.
- Legislation: The UK will no longer have to incorporate EU Directives in domestic legislation, being free to set its own rates and decide which supplies might be zero rated. Additionally, decisions of the Court of Justice of the European Union would no longer impact UK VAT rules.
- Abolition of VAT: The UK could decide that we do not need to account for VAT on the domestic supply of goods/services. Given that VAT accounts for approximately one fifth of the UK tax revenue this is unlikely. However, a replacement Sales Tax could be implemented.
- VAT rate: The UK VAT rate will no longer be subject to EU requirements to maintain the rate within a certain range, freeing the UK government to increase or decrease VAT.
- Increased complexity: There is the possibility that UK B2C businesses active within the EU will have an increased VAT compliance burden with the requirement to file returns in up to 28 jurisdictions.
- Reduced compliance: VIES/EC sales listings and Intrastat filings will no longer be relevant for supplies of goods and services into the UK.
- Additional reporting: EU suppliers may have UK VAT registration obligations in certain situations, such as services provision, where they do not need to do so currently.
From a tax perspective, the impact could be highly disruptive. Businesses will face additional administrative requirements and there could be detrimental cash flow costs on importing goods from Europe and higher potential pressure on prices for UK shoppers.
Customs Duty is mainly governed by EU Directives and Regulations, with rates set by the EU. Post secession, the UK would need to introduce legislation for a replacement UK Customs Duty system.
The impact for business depends entirely on whether or not the UK enters into some form of replacement Customs Agreement with the EU (there is a precedent for this, the EU has a Customs Union with Monaco and Turkey) for tariff-free trade. The impact of leaving the Customs Union is that:
- Acquisitions become imports: Goods coming into the UK from the EU and vice versa, will be classed as imports thereby attracting customs duty. This will increase the landed cost of many goods which are no longer classified as acquisitions.
- Trade tariffs: We could see trade tariffs imposed, regulated by the World Customs Organisation, unless the UK retains EEA (European Economic Area)/EFTA (European Free Trade Association) membership.
- Increased compliance costs: The requirement to complete import and export declarations will create a bottom line customs cost and add to compliance costs.
- Decreased compliance costs: Cost savings will be generated by the fact the ECSL Intrastat reports for intra EU sales will not need to be prepared.
- Deferment account: Businesses will have to increase their deferment account guarantees to cover the additional quantities classified as imports to ensure the goods are released from customs.
- Duty rates: These will now be under the control of the UK.
- Legislation: Domestic legislation will need to be implemented to cover certain Customs processes such as, the Authorised Economic Operator programme, duty suspension etc.
Note: Jon Thompson, Chief Executive of HMRC, in giving evidence to the Treasury Committee on 23rd May 2018, cautioned that the number of customs declarations could increase four- fold, from 55 million to 205 million, creating significant pressures on the system and businesses. He estimates a hard Brexit could see customs costs spiral, costing UK and EU businesses up to £20 billion, with costs to EU businesses passed on to UK consumers, although those figures have been challenged by the Institute for Economic Affairs which estimates the cost will be £5 billion.
The cessation of membership of the EU is going to have less of an impact on Direct Tax. As some EU Member States wish to progress the move to a common EU corporation tax rate, direct taxes are set domestically in accordance with European Treaties. However, secession means that many of the EU Directives need no longer be followed:
- EU Parent Subsidiary Directive: which provides relief for withholding taxes on dividend payments made between associated companies in different EU Member States, will no longer apply in the UK. Note: The substantial shareholding exemption has been enshrined in UK tax law since 2002 and it is unlikely that the measures would be removed entirely.
- Interest and Royalties Directive: which seeks to abolish withholding taxes on interest and royalty payments between Member States will no longer apply in the UK. Existing double taxation treaties for withholding taxes on dividends, interest and royalties may not provide full relief.
- Merger Directive: which offers tax relief for cross-border reorganisations will not be available meaning reorganisations, such as mergers with EU entities, could result in increased tax costs for UK businesses.
- Mutual Assistance Directive and Recovery Assistance Directive: allow for exchange of information between EU Member States. However, the UK has signed the OECD/Council of Europe Multilateral Convention on Mutual Assistance in Tax Matters. This, together with the adoption of BEPS Actions such as Action 5 for countering harmful tax practices and Action 13 for Country by Country Reporting, means that information exchanges will continue.
Other direct tax implications of leaving the EU:
- The four EU Treaty freedoms: In the past UK direct tax legislation has had to be amended to remove infringements, this will no longer be required.
- EU definitions: UK tax legislation uses the EU recommendation concerning the definition of the size of an enterprise.
- State Aid: Budgetary tax incentives announced in the UK have often required state aid approval from the European Commission before they come into effect so that they do not constitute unlawful state aid. This will no longer be an issue. However, the UK may be required to comply with the state aid doctrine if the UK wishes to remain in the EEA or EFTA.
- Cross border loss relief: To maintain tax competitiveness, the UK government may well decide to maintain cross-border loss relief so as not to restrict taxpayers’ freedom of establishment. These UK laws were implemented in FA2000 as a result of the ECJ Marks and Spencer v Halsey case.
So, what can UK or EU businesses do to prepare for the implications of Brexit on tax? There are still too many unknowns to be able to prepare for all eventualities but there are steps you can take:
- Examine your customs process. Leaving the customs union means that British companies will need to fill in customs declarations for all goods crossing the EU border so you must ensure you make appropriate updates to your systems for the production of customs declarations, communicating with the EU’s customs systems and the equivalent new UK electronic customs declaration system.
- Map and review your supply chain, so you can assess the possible tariffs that might apply. You may even go so far as to consider whether or not you should be substituting domestic suppliers.
- Review your contracts to ensure that they clearly state the terms for trade across EU borders and how VAT should be reported.
- Ensure that invoicing templates are updated so that business VAT reporting requirements will be met with all the necessary VAT registrations are in place.
- Consider the potential benefits of obtaining Authorised Economic Operator status, this can be a protracted exercise taking up to a year, but may be beneficial as it could facilitate faster clearance at borders.
The 21-month transition period is there to give businesses the time to adjust and to put systems and processes in place in order to minimise and manage the impact of Brexit. It goes without saying that a time of transition is a time of change. It is how we deal with that change that will determine whether or not we overcome, and indeed benefit from, the challenges ahead. Those businesses that do get their house in order will be in a much better position to adapt quickly to legislative changes.
As Albert Einstein said, “In the middle of difficulty lies opportunity”.