Brexit’s impact on corporate taxation and transfer pricing
The UK voted on June 23, 2016, to exit the European Union ('EU'). Even though it is not yet entirely clear if, when or how Article 50 of the Lisbon Treaty on European Union (which governs a member state’s voluntary withdrawal from the EU) will be triggered, the consequences of a potential exit by the UK may be far reaching for multinational companies engaging in cross-border transactions involving the UK.
Exchange rate volatility, increased transaction costs and potential pressure on the UK economy are likely to contribute to the need for changes in the transfer pricing policy and documentation strategy employed by multinationals with UK operations. This may result in multinationals shouldering additional costs of managing divergent transfer pricing legislation if the UK exits.
Not being in the EU would remove the UK’s powers to influence EU level tax matters such as its ability to oppose/influence the enhanced co-operation procedure ('ECP') and the financial transaction tax ('FTT') proposal, which could be adverse to UK businesses.
Nevertheless, a Brexit would have no impact 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 bound by the double-tax treaties already in force. Other key considerations resulting from Brexit are as follows:
EU member states
Germany and France may get their way by revitalizing a plan to develop a single set of rules that would allow cross-border companies to file a single tax return for their EU activities, according to European Parliament members and tax practitioners. One argument frequently put forward supporting the Germany and France plan is that the U.K. government will be keen to establish tax incentives to keep businesses from leaving and attract new investment. However, this may result in a dichotomy between EU tax law and future, post-exit UK tax legislation.
Value added tax
EU membership requires that states do not impose individual sales taxes but, instead, operate VAT based on rules determined by the EU with limited variations (including the VAT rate) applied in individual member states. Although VAT would no longer be mandated by the EU, it is unlikely that the UK would scrap the tax. However, the UK would not be bound by EU court decisions and would have greater flexibility with respect to how the charge is applied. Supplies of goods and services between businesses in EU member states may return to being treated as imports and exports, as is currently the case for transactions with trading partners based outside the EU.
The UK will no longer be required to follow the parent-subsidiary directive (‘PSD’). Generally, the PSD provides that where a parent company in one EU member state receives distributions of profits from a subsidiary company in another member state, only the member state of the parent company may tax the receipt. This prevents the application of withholding taxes on payments of interest or dividends made between group companies, both of which are residents in EU member states.
If the PSD no longer applies, a group of companies with a parent company in the UK and subsidiaries in an EU member state (or vice versa) may become subject to double taxation with respect to profit distributions unless a double-tax treaty or similar arrangement prevents this. However, the UK is one of the jurisdictions that has concluded the most double-taxation agreements, including agreements with all current members of the EU. The UK does not operate a withholding tax system for dividends paid out of the UK, and this is unlikely to change. As such, monitoring will be required for inbound dividend income and interest payments to the UK.
The UK will no longer be required to carry out the merger directive (‘MD’), which is designed to remove fiscal obstacles to cross-border reorganizations. In the case of mergers involving a company transferring assets and liabilities to one or more companies in a different EU member state, the MD provides for a deferral of the taxes that could be charged on the difference between the real value of such assets and liabilities and their value for tax purposes, subject to certain conditions.
Assuming the UK is no longer part of the European Economic Area and does not join European Free Trade Association 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 is that the UK will no longer have any recourse through the EU against member states introducing state aid that puts UK businesses at a disadvantage.
Capital duties directive
The UK will no longer be required to implement the capital duties directive ('CDD'). The CDD prevents, in some instances, EU member states charging indirect tax from the raising of capital by companies (i.e., issuing shares or other securities).
UK legislation currently imposes a stamp duty reserve tax (‘SDRT’) on issues of shares and securities to depositary receipt issuers and clearance services in certain circumstances. However, the CDD and decisions of the Court of Justice of the European Union and First-Tier Tribunal, HMRC, announced it would no longer seek to impose a SDRT.
If the UK left the EU, the UK government would be free to impose this SDRT as well as a new capital duty, assuming it did not enter into similar arrangements with EU member states. However, the potential impact on London as a global financial center by imposing new charges seems unlikely. Nevertheless, Brexit still has a long road ahead. Stay tuned.