#GotBrexitDone?

The United Kingdom left the EU on 31 January 2020.  “Brexit” will undoubtedly be remembered as an important event in the history of the United Kingdom.  In the taxation context, however, it is only natural for us to ask the questions: have we “Got Brexit Done” and, if so, is that a big change for UK taxes?

The short answers are as much of an anti-climax as the famous British weather.  Brexit, at least in the tax context, has been partly “done.”  And as regards a big change happening to UK taxes, the answer is “not much (yet).”   In both regards, it is useful to mention that the immediate tax changes are mostly unintended by the British government.

This is because the UK and the European Union have entered into a withdrawal agreement, which was ratified before 31 January 2020 (the Withdrawal Agreement).  At 11pm on 31 January 2020, the UK and the EU entered into a transitional (or, as the UK prefers to call it, “implementation”) period, during which most EU rules will continue to apply in, and in respect of, the UK.

The UK is not free from the EU rules yet…

The reason for having a transition period is to provide both the UK and the EU with a standstill period during which they negotiate additional arrangements.

The Withdrawal Agreement provides that most EU law (including as amended or supplemented) continues to apply to, and in, the UK and most references to “EU member states” in EU law (including as implemented and applied by EU member states) include the UK.

This means, for example, that the UK is still within the EU VAT regime, customs union and single market.  All of the EU tax directives remain in place for the UK during the transitional period, meaning that UK companies can still take advantage of the Interest and Royalties Directive and the Parent-Subsidiary Directives to repatriate funds from and to EU subsidiaries or parents without being subject to withholding tax.

This also means that the UK remains under an obligation to implement outstanding EU tax directives.  These include (to the surprise of some commentators on popular social media sites) the EU’s Anti-Tax Avoidance Directive 2 (ATAD 2) and the EU’s Sixth Directive Amending the Directive Cooperation in Tax Matters (DAC 6).  On an even closer inspection, Brexit has little impact in practice on the implementation of these existing EU tax directives.  The UK has already committed itself to the implementation of DAC 6 (despite Brexit) and has already complied with the provisions of ATAD 2 by, for example, introducing UK tax legislation counteracting “hybrid” mismatch arrangements.

… but there are some changes, albeit unwanted by the UK government

However, it’s not all plain sailing.  There are some potential impact on treaties which exist with third countries and the EU, or an EU member state other than the UK (each an EU27 country).  This is because third parties are not bound by the UK-EU Withdrawal Agreement, and therefore are not obliged to treat the UK as an EU member state during the transition period.

The most important example in a direct tax context is probably the double tax treaties entered into by the United States with EU27 countries.  Most of the U.S. double tax treaties contain a limitation on benefits (LOB) provision, which limits the benefits in the double tax treaty unless certain substance tests are met. One category of “qualified persons” allowed to claim treaty benefits under a LOB provision are those payees which are at least 95% owned by “equivalent beneficiaries,” subject to certain other conditions.  “Equivalent beneficiaries” are those entities which would be entitled to the equivalent relief under an applicable U.S. tax treaty if they had received the income directly.  However, many U.S. treaties with EU member states (such as the U.S.-Ireland double tax treaty) restrict the definition of “equivalent beneficiaries” to residents of member states of the EU (or the European Economic Area (the EEA)) or parties to the North America Free Trade Association.  Now that the UK has left the EU (and, in the true spirit of Brexit, also left the EEA), some EU companies with UK owners may no longer rely on the “equivalent beneficiaries” provision and thereby the relevant double tax treaty. Therefore, if a U.S. double tax treaty with an EU27 country has been relied upon, it is necessary to closely review the company structure of the payee to examine whether it might lose any protection under that treaty by reason of falling out of the scope of the “equivalent beneficiaries” provision.

Another example of a treaty between the EU and a third country are the various free trade agreements (FTAs) entered into worldwide to facilitate cross-border trade.  As the UK leaves the EU, third countries are not obliged (even during the transition period) to treat the UK as an EU member state under those FTAs with the EU (of which, of course, the UK was a member of until January 31).  By contrast, the UK remains bound by the Withdrawal Agreement to comply with the obligation stemming from those EU FTAs.  The complex inter-relationship of FTAs to which the EU has entered, and the dynamics of how the UK remains bound by the terms of those FTAs, is likely to be highly relevant in the area of customs duties, tariffs and indirect taxation.  Under the Withdrawal Agreement, the EU shall notify the other parties to these EU-third country FTAs that during the transition period the UK is to be treated as an EU member state for the purposes of those FTAs.  It is then up to those third countries to decide whether they will accept to treat the UK as an EU member state for the purposes of these FTAs during the transition period.

Cliff edge 2.0 (or 4.0?)

The end of the transition period represents yet another cliff edge.  The extent of changes at the end of the transition period depends on the terms of any trade agreement between the UK and the EU, and in particular the extent of divergence the UK seeks.

If no future relationship agreement is reached at the end of the transition period, the Withdrawal Agreement backstop (including the Northern Ireland protocol) would come into effect and some of the aspects of a (so-called) “no-deal Brexit” would arise again.  This could potentially result in the UK (other than Northern Ireland) departing promptly from well-known EU trading structures (the single market, the customs union and the EU-wide VAT regime).  The UK would also be likely to lose the benefits of EU tax directives, such as the Interest and Royalties Directive and the Parent-Subsidiary Directive.  It is worth noting that the end of the transition period is currently scheduled to take place at 11 p.m. on 31 December 2020 (less than 11 months from the date of this article).

For the rest of the transition period, therefore, we should be prepared for some bumpy rides ahead, especially when the UK is trying to negotiate two trade deals at the same time – one with the EU and one with the U.S.  Threats of cliff-edges and a “no-deal Brexit” are likely to feature in the press and online media once again during the negotiation process.

Despite the uncertainties ahead, clients and UK businesses are well placed, and advised, to brace themselves during the transition period.  Of particular interest will be the UK Budget scheduled for 11 March 2020, when the UK government might reveal more of the technical details which will frame the post-Brexit UK tax environment. 

And, as with a variety of other matters (not all of which relate to law and tax), it is very much a case of keeping calm and carrying on regardless.

 

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