The expected departure of the United Kingdom (UK) from the European Union (EU) is undoubtedly a surprise to many businesses and their professional advisors. Even though there was much speculation about the possibility of an “exit” vote, “smart money” seemed to believe it likely that the UK would remain in the EU.
Given the many associated uncertainties, the full range of implications resulting from Brexit cannot be fully assessed at this time. Predictions concerning future UK tax, customs and regulatory policies in response to Brexit amount to pure speculation and provide little basis for reliable planning. This said, it is important to gain a clear understanding of the situation, consider the potential impact on UK-based international structures, and begin the process of developing plans to manage potentially adverse effects of Brexit.
What Happened and Why Does It Matter for U.S. Businesses?
The UK voted in favor of exiting the EU in a referendum held on June 23, 2016. The UK has been part of the EU for more than four decades and its membership influenced the development of tax rules applicable to UK businesses and multinational enterprises (MNEs) operating in the UK For example, UK companies could rely on EU directives designed to limit instances of double taxation and otherwise facilitate cross-border business activity within the EU. In addition, specific UK rules were often crafted to conform to EU law (i.e. the Patent Box regime was modified in the light of comments received from the EU and the OECD).
Certain decisions of the European Court of Justice have also impacted the practical application of UK tax rules. Notable examples in this regard are the landmark decisions in Cadbury Schweppesi (pertaining to the operation of the UK Controlled Foreign Corporation rules) and Marks and Spencerii (concerning the use of losses from a group member incorporated in a different EU country). At this juncture, it is difficult to assess how the disassociation of the UK from the EU will impact the evolution of the UK tax environment.
Many U.S. MNEs, U.S. financial institutions and fund managers have chosen to base their foreign operations in the UK. While this decision typically would have been influenced by multiple factors, undoubtedly the many advantages associated with an EU location would have been an important consideration. It is therefore reasonable to expect that in some instances, U.S. companies may now seek to relocate all or part of their UK activities elsewhere in the EU.
What Are Some of the Tax Implications Associated with Brexit?
Some of the more obvious associated tax implications are as follows:
Withholding taxes. The EU Parent-Subsidiary Directive abolished withholding taxes on payments of dividends between associated companies of EU member states. In addition, the EU Interest and Royalties Directive requires member states to remove withholding taxes on cross-border payments of interest or royalties between associated companies. The impact of the unavailability of these directives due to Brexit may be mitigated by the extensive network of UK bilateral tax treaties which operate to reduce withholding taxes on dividends, interest and royalties. The availability and the extent of bilateral treaty benefits must be evaluated in each specific instance involving the cross-border payment of dividends, interest or royalties involving a UK party.
Cross-border mergers within the EU. The EU Merger Directive has the broad aim of allowing EU enterprises to establish operations in different member states without resulting in taxation in the member state from which assets are transferred. The inability to rely on this directive as a result of Brexit may complicate certain types of restructurings involving UK entities.
Other EU Directives. Certain other EU directives dealing with information exchange and administrative cooperation are less visible, yet nevertheless contribute to overall administrative efficiency.
Customs and Duties. It is likely that the most significant short-term impact of Brexit will be in this area.
The UK may seek to adhere to those EU directives that support its position as a hub for EU-bound MNEs. In any event, the broader framework of OECD tax policy (including the “BEPS” or Base Erosion Profit Shifting initiative) could serve as a unifying base for common approaches in the field of taxation for EU, the U.S. and other OECD members (especially in areas such as transfer pricing). These and other extrinsic factors may operate to somewhat limit the practical effect of Brexit on the UK tax environment.
When Should We Expect Changes and What Should U.S. MNEs Be Doing Now?
The UK has approximately two years to negotiate its departure from the EU. According to many observers, the actual time that it may take to renegotiate and implement all of the required changes may take as long as five to seven years. This view is based on similar experience in negotiating free trade agreements between the EU and South Korea and Turkey, respectively. President Obama stated that the renegotiation of the UK – U.S. trade agreements may take as long as 10 years! It remains to be seen how long it will take to realign the many complex arrangements that will be unwound by Brexit.
The resulting uncertainty could inspire competition between jurisdictions culminating in a more business-friendly international commercial environment. With so much uncertainty, stakeholders should seek to foster constructive change by voicing their support of appropriate policy initiatives. As such, Brexit may ultimately serve as the impetus for a certain degree of positive change.
In addition, for those enterprises wishing to explore the relocation of UK activities elsewhere in the EU, a careful consideration of relevant tax issues is important. Among the tax issues which should be evaluated is the potential tax cost resulting from the transfer of UK-based tangible and intangible assets as well as the selection of appropriate alternative EU jurisdictions and vehicles. For a UK subsidiary of a U.S. parent company, the UK, U.S. and EU tax implications of a relocation of the UK business should be carefully evaluated before proceeding, in light of the risk of triggering immediate taxation of “phantom income”.
i Cadbury Schweppes plc, Cadbury Schweppes Overseas Limited v. Commissioners of Inland Revenue, Case C-196/04  E.C.R. I-7995
ii Marks & Spencer plc v. David Halsey (Her Majesty’s Inspector of Taxes), Case C- 446/03  E.C.R. I-10937