This article was published prior to the publication of the post-Brexit agreement between the UK and EU which covers the relationship between the UK and EU following the end of the implementation period (commonly referred to as the “transition period”) created by the European Union (Withdrawal Agreement) Act 2020, and should be read in that context. For up-to-date commentary and information on our services, please see our Beyond Brexit page.
The tax implications of a UK exit from the EU would be hinged upon what other agreements the UK is able to hammer out post exit. The UK’s membership of other international organisations, such as the OECD, and its many other bilateral tax treaties would continue to limit its ability to set a completely individualistic tax policy.
In general terms, not being in the EU would remove the UK’s powers to impact EU level tax matters and a Brexit would not leave a footprint on the UK’s extensive double tax treaty network, which is not based on EU Membership. The UK would, therefore, still benefit from and be compelled by the double tax treaties already in force.
However, a Brexit could contract the UK's muscle in international tax policy, as the EU exercises sizeable influence over the future direction of BEPS and OECD policy in general.
The most palpable consequence of Brexit would be in relation to indirect taxes, most notably VAT.
Value Added Tax ("VAT")
VAT is a European Tax and so currently the UK's VAT legislation must be directly in line with the EU Principal VAT Directive (PVD). EU tax payers are able to rely on EU law and European Court rulings must be adhered to. At present, this harmonisation with other EU Member States facilitates European trade.
In the event of a Brexit, UK VAT would no longer be governed by EU law and the UK could make possibly far reaching changes to the VAT system. It would be open to the UK to change how VAT is charged in the UK, or even to replace it with an altogether divergent tax.
The most likely and proximate changes would be of a mechanical nature. For instance, methods of reclaiming VAT from EU tax authorities and the potential loss of access to the EU 'one-stop shop' instruments. These are being introduced in various areas of VAT to remove the burden for a business which would otherwise be required to register for VAT in up to 28 jurisdictions and the Triangulation simplification measures (goods moving within the EU in the course of a supply chain including VAT registered businesses).
If the UK chooses to leave, we can only hypothesis that the old rulings will not continue to be binding, which will afford the UK the ability to choose rates without the need for EU endorsement.
A Brexit would unlikely alter the landscape of the UK VAT system in the short term; however, we will likely see some gradual changes, with new rules emerging over time.
It is less probable that direct taxes will be entirely affected by the UK leaving the EU. Unlike indirect taxes, direct taxes are not distinctly dealt with by the EU Treaties. The engineering of direct tax matters tend to be a matter for the individual member states. However, they take heed of the EU fundamental freedoms. There are some relevant EU Directives, which are primarily aimed at removing barriers for businesses operating within the EU. These include, but are not limited to, the Merger Directive and the Parent-Subsidiary Directive.
The Merger Directive
This applies to mergers, divisions, transfers of assets and exchanges of shares that take place between companies in different member states. If the UK leaves the EU, it will no longer be required that the Merger Directive applies on transactions with the UK. This Directive is designed to remove economic burdens to cross-border reorganisations.
In the case of mergers involving a company transferring assets and liabilities to one or more companies in a different EU Member State, the Merger Directive provides for a deferral of the taxes that could be charged on the difference between the actual value of such assets and liabilities and their value for tax purposes.
If the UK leaves the EU it will not need to comply with the Merger Directive and, accordingly will be free to levy tax on cross-border mergers of UK businesses.
The Parent-Subsidiary Directive
This Directive 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, 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 the Parent-Subsidiary Directive no longer applies, double taxation in respect of profit distributions may apply, unless a double tax treaty or related arrangements prevent such an occurrence from materialising.
Corporation Tax ("CT")
CT is a UK tax, not an EU tax, so the UK is free from curtailment within reason to set their own rules. In the event of Brexit the UK must have a competitive rate to attract overseas investment, or the UK would lose out on such investments and the economic cost would prove highly detrimental.
If the UK does leave the EU, it is highly unlikely that the UK would set anything but competitive CT rates and rules.
In the event of a Brexit, numerous marked changes could be manufactured, ultimately altering the UK tax code. In the short term, however, it is possible that things would continue much the same as they are now. If the UK left the EU, the way in which the UK tax system would be operated would to a large extent hinge upon the details of any UK settlement with Europe.
A Brexit 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, as set out above; however, it could provide certain other benefits. A UK government unimpeded by EU state aid rules and fundamental freedoms could provide UK businesses with more advantageous tax treatment than that provided to other businesses. However, for now at least it is very much a 'wait and see' situation.