The UK ceased to be a Member State of the EU on 31st January 2020 and Brexit was followed by the ‘transition period’ which ended on 31st December 2021. Almost at the last moment the UK and the EU concluded the UK/EU Trade and Cooperation Agreement (“TCA”) which imposes several restrictions on the UK, including controls on subsidies and commitments to maintain certain OECD tax standards.
Tax partner Andrew Terry explains how the UK tax regime has changed after Brexit and discusses whether the UK will become more attractive when compared to the remaining 27 EU Member States.
Prior to the signing of the TCA, there was media speculation that the UK might seek to rebrand itself as a kind of ‘Singapore-on-Thames’ – effectively a tax haven which offered aggressively lower tax rates than its EU neighbours, coupled with tax incentives to encourage business to the UK. It was also thought that the UK might to some extent water down its existing rules on tax avoidance such as those on tax disclosure or its controlled foreign company rules.
Under the TCA provisions dealing with ‘subsidy controls’ (state aid by another name), the UK binds itself to rules equivalent to those in the EU. These prevent the UK from being able to offer a whole range of tax incentives aimed at specific situations tailored to attract business to the UK. The UK does have control over its corporation tax rate (as it did when a Member State) but this is increasing to 25% rather than reducing from 19%.
Under the TCA, both the UK and the EU have agreed to maintain OECD standards in the remit of tax transparency and certain of the OECD base erosion and profit shifting (BEPS) actions. Specifically, these relate to the rules on the restrictions on corporate interest deductibility, anti-hybrid mismatches and controlled foreign companies. The parties have also agreed to uphold the principles of good tax governance as defined by Chapter 5 of the TCA, although how this is supposed to be implemented in practice is not yet clear.
It seems clear that in the short term, there is little chance of London morphing into anything like a ‘Singapore-on-Thames’. If the UK were to take action such as abolishing its tax disclosure rules, then potentially it could be placed on the EU backlist of non-cooperative jurisdictions. In practice, it is doubtful that the UK would do anything to risk provoking such a response from the EU.
The UK is no longer part of the EU VAT system, so it is now free to make changes to its VAT legislation. It is anticipated that in the medium to long term the UK VAT rules will diverge from those of the EU. Crucially, the UK is now free to set its own VAT rate where it wishes and is not limited to maintaining a standard rate which is at least 15% or the reduced rate of at least 5%. The UK’s current standard rate is 20% but the need to raise revenue post-Covid-19 probably makes a reduction to this rate unlikely any time soon.
The UK does not generally apply withholding taxes to dividend payments under its domestic tax law, with the one small exception to this general position being the distributions of profit by real estate investment trusts. Dividends may be paid gross by a UK company whether the recipient shareholder is UK resident or non-UK resident (even if resident in a tax haven) without the need to rely on a double taxation agreement.
The EU Parent/Subsidiary Directive
Until the end of the transitional period, the UK was a party to the EU Parent/Subsidiary Directive which enables dividends to be paid gross between EU Member States (and Switzerland) where, broadly, the companies were associated. This meant that, subject to certain conditions, under the Directive a non-UK subsidiary could pay dividends to its UK parent company without suffering any local dividend withholding taxes.
Although the benefit of the Directive is no longer available to UK resident companies, many of the double taxation agreements to which the UK is a party reduce the level of withholding taxes on dividends to nil (the UK/Switzerland agreement, for example). However, under some agreements a withholding tax will still be charged, as the relevant agreement between the UK and the country of the dividend paying company does not reduce dividend withholding tax to zero. This is the case under the both the UK/Germany and the UK/Italy agreements, which both allow for a 5% withholding tax on payment of a dividend to a UK company that has at least a 10% shareholding.
This level of withholding tax may be considered acceptable, but unless the agreements can be renegotiated, it does make the UK a slightly less attractive location for a group holding company.
The EU Interest and Royalties Directive
Under the EU Interest and Royalties Directive, payments of interest and royalties between companies resident in different EU Member States can be made without withholding tax. Even though the UK is no longer a party to this Directive, the provisions had been incorporated in UK law and are still in force. However, in the recent Budget it was announced that they would be repealed for payments made on or after 1st June 2021.
This means that from this date a UK company making a payment of interest and certain royalties to an EU company will be obliged to withhold income tax at the rate of 20% unless a lower or nil rate is available under a double taxation agreement. Most of the UK’s double taxation agreements do reduce withholding tax on interest and royalties to nil but this is not always the case. For example, a 10% interest withholding tax will apply on payments from the UK to Latvia, Portugal, and Romania. This is a small further example of how the UK has become slightly less competitive from a tax viewpoint following Brexit.
In conclusion, the UK is restricted by the TCA specifically in relation to matters such as subsidy controls and OECD BEPS standards, so it cannot move to a quasi-tax haven status and repeal its tax disclosure rules and CFC rules. However, outside of the TCA restrictions, the UK is able to make its tax regime more competitive than that of its EU 27 former partners including reducing both its corporation tax rate and VAT rate. However, such tax reductions are likely to remain no more than a long-term goal at the present time due to the need to meet the continuing costs of COVID-19.