- The Brexit
On 23 June 2016, the majority of the voters in the United Kingdom (hereafter also "UK") opted to leave the EU ("Brexit"). This is a landmark event as no nation has ever left the EU.
In this Alert we will briefly discuss certain possible tax consequences of the Brexit. In view of the many variables involved, however, this tax Alert may often only offer speculation on possible outcomes.
Timing and strategic considerations on submitting the Article 50 Notice
The rules for an exit are set out in Article 50 of the Treaty on European Union, stating that a Member State that decides to withdraw shall notify the European Council of its intention. After such withdrawal notice (the "Article 50 Notice") the United Kingdom and the EU must negotiate an agreement regulating the framework for the future relations between the United Kingdom and the EU. Once such agreement is in place, the EU rules cease to apply to the United Kingdom from the date of entry into force of such agreement. Failing an agreement, the EU rules cease to apply two years after the Article 50 Notice unless the European Council, in agreement with the United Kingdom, unanimously decides to extend this period.
Once the Article 50 Notice is submitted, the UK's bargaining power in negotiating its relationship with the EU following its exit, will be substantially reduced. This explains why not only the UK government but also the leading Brexit campaigners are in no hurry to initiate the Article 50 procedure. Current media speculation is that the Article 50 Notice may not be submitted until the fall of 2017.
In view of such procedure, the United Kingdom in the meantime remains a member of the EU and, likely, there would not be any immediate change in either EU or United Kingdom law as a consequence of the outcome of the referendum. However, the delay of the submission of the Article 50 Notice extends the period of uncertainty regarding the consequences of the Brexit and the future relationship between the UK and the EU.
Future relations between the UK and the EU
There are several scenarios for the relationship between the UK and the EU after the Brexit. Some of the most discussed scenarios are the following (for a more detailed discussion please refer to our Brexit webpage):
- The Norwegian scenario: The UK becomes a Member of the EEA and EFTA;
- The Swiss scenario: The UK becomes a member of EFTA and concludes a number of bilateral trade agreements with the EU;
- The Mexican-Canadian scenario: The UK concludes a number of bilateral trade agreements with the EU;
- The Turkish scenario: The UK and the EU enter into a customs union; or
- The default (China) scenario: The UK has to rely on its WTO membership.
Some of these scenarios would likely be politically unacceptable to the UK government or at least to the Brexit campaigners; others would likely be politically unacceptable to the remaining 27 EU Member States. In any case, the two year deadline set by Article 50 may very well prove to be too short to fully settle the relationship between the UK and the EU, due to the complexity of the negotiations needed for most of the above scenarios, especially taking into account that the UK has been an EU Member State for over four decades.
- Impact of Brexit on EU law - The tax perspective
EU Fundamental freedoms
Relevance for tax purposes
The EU fundamental freedoms comprise of the freedom of establishment, the free movement of capital, the free movement of persons and the free movement of goods and services. These EU freedoms form the cornerstone of the Single Market and afford taxpayers resident in one EU Member State the right to establish a subsidiary or branch in another EU Member State and to conduct their business in another EU Member state free from discriminatory taxes and without tax related restrictions both in their EU Member State of residence and in the other EU Member State. These freedoms have significant impact on domestic direct tax systems of the EU Member States as case law of the European Court of Justice ("ECJ") and also national courts has shown over the past few decades. Withholding taxes, exit taxes, tax grouping rules (such as the UK Group relief), etc. have been tested before the ECJ and have ultimately led to the abolishment or amendments of the domestic tax rules containing such discriminatory rules.
Post Brexit situation
The Brexit implies that the EU fundamental freedoms laid down in the EU Treaty will no longer apply in relation to cross-border economic activities between the UK and the other 27 EU Member States. This may be different in the event that the UK would chose the Norwegian scenario and become part of the EEA. However, given the positions taken by the UK/Brexit campaigners and the remaining EU Member States, this would at the moment appear to be an unlikely scenario. An exception to the rule that the EU fundamental freedoms cease to apply is the free movement of capital, which will still apply vis-à-vis third (i.e. non-EU Member) States, albeit with certain restrictions. As a result of the Brexit, UK resident companies would therefore no longer be protected from discriminatory tax treatment and tax related restrictions when setting up subsidiaries or branches in an EU Member State, unless the UK company can invoke the free movement of capital which continues to apply in relation to the UK. This would not only apply to the relevant EU Member State, but also the UK itself would no longer be barred from introducing such measures. The same would apply in the mirror situation, where an EU resident company sets up a subsidiary or branch in the UK.
The above consequences may, however, be mitigated by the non-discrimination rules included in double tax treaties concluded between the UK and EU Member States, which will continue to apply. However, typically the non-discrimination rules in double tax treaties afford less protection than the EU fundamental freedoms. The main difference is that the latter also prohibit tax measures that restrict cross border movements, without being discriminatory as such.
State Aid & Code of Conduct
Relevance for tax purposes
Under the EU Treaty State Aid is prohibited. This prohibition also extends to selective tax advantages. The European Commission is also using the EU State Aid rules to combat certain harmful tax practices. Prominent examples of where the EU Commission has applied the State Aid rules include the Apple case, the Starbucks case and the Fiat case. Particular fields where State Aid plays a prominent role, include the freedom of an EU Member State to implement preferential tax regimes, the implementation of tax holidays or tax exemptions for certain categories of taxpayers and the granting of advance tax rulings, but also the granting of subsidies. Tax measures in these fields are prone to State Aid challenges.
Apart from the State Aid rules, there is also the Code of Conduct for business taxation (the "Code"), which requires EU Member States to refrain from introducing any new harmful tax measures and amend any laws or practices that are deemed to be harmful in respect of the principles of the Code. The Code especially restricts the freedom to implement preferential regimes. The Code is not a legally binding instrument, but it clearly does have political force.
Post Brexit situation
As the State Aid rules would in principle no longer apply after the Brexit, the United Kingdom can in principle grant State Aid to its businesses, for instance in the form of a specific exemptions, but also through the granting of subsidies. However, the most relevant aspect would probably be that the UK is free to implement preferential tax regimes designed to attract business to the UK in order to compensate for the loss of certain of the benefits of the EU membership. In addition, the UK would also no longer be bound by the Code, which continues to apply to the remaining 27 EU Member States. However, having said this, several of the scenarios that entail a certain level of access to the single Market would – if implemented along the lines as the examples - imply the application of the EU State Aid rules. In addition, it seems unlikely that the remaining 27 EU Member States would be willing to grant the UK some form of access to the single Market without the acceptance by the UK of the prohibition on State Aid.
Relevance for tax purposes
VAT is largely harmonized within the EU by way of a Council Directive and certain regulations, albeit that the EU Member States are free to implement certain elements of the EU VAT rules to their own discretion, for instance the rates involved and certain exemptions. The uniform application of EU VAT rules is guarded by the ECJ. The EU VAT system provides for mechanisms to make sure that VAT is only levied with respect to the supply of goods services to the end user and that no double charges apply to supplies within the EU (for instance through the VAT exemption for intra-community supplies or through cross border VAT refunds).
Post Brexit situation
Once the UK has left the EU, the EU VAT rules cease to apply in respect of the United Kingdom. Absent agreements between the EU and the UK that provide otherwise, this implies that import and export between the EU and the UK may become subject to EU VAT, that the administrative burden in respect of for UK business operating in the EU will increase (e.g. need for a VAT representative in the EU) and that double VAT charges may arise on transactions between the EU and the UK.
Should the UK opt to maintain its VAT system after the Brexit, then such system will likely not remain fully aligned with subsequently issued new EU VAT rules and ECJ rulings, causing a divergence of UK and EU rules with all administrative and VAT costs that may ensue.
Customs or import duties
Relevance for tax purposes
Goods can be circulated within the EU free of import duties. With respect to importation from third countries (i.e. non-EU Member States), EU import duties may apply.
Post Brexit situation
Once the UK has left the EU it would be to its own discretion to levy import duties on trade from EU Member States, while the EU would have the same discretion. Accordingly, it cannot be excluded that the Brexit will lead to imposition of custom duties with related procedures on import and export between the UK and the EU.
EU Tax Directives
The Parent Subsidiary Directive grants qualifying parent companies receiving dividends from their subsidiaries, resident in other EU Member States, a tax exemption or a tax credit for the dividends received (see also our Tax Alert of September 2015). In addition the EU Member State of residence of the subsidiary is not allowed to levy withholding tax at the level of the subsidiaries paying such dividend.
The Interest and Royalties Directive provides for an exemption of withholding tax if a company makes a cross border payment of interest or royalty, respectively, to qualifying affiliated companies within the EU.
The Merger Directive provides for a tax roll over relief in respect of capital gains in connection with certain cross-border mergers, divisions, exchanges of shares and transfers of assets.
Post Brexit situation
Post-Brexit, the Parent Subsidiary Directive and Interest and Royalty Directive would no longer apply and thus the UK would be free to levy withholding tax if a UK resident company pays intra-group dividends, interest or royalty to an EU group company (subject to reductions under existing bilateral tax treaties with individual EU Member States). Conversely, EU Member States would also be free to levy withholding tax in respect of such payments to an United Kingdom resident company (again, subject to applicable bilateral tax treaties).
The benefits of the Parent Subsidiary Directive and the Interest and Royalty Directive may be more extensive than those granted under bilateral tax treaties that the UK has in place with individual EU Member States. Loss of access to these Directives may thus negatively impact investments between the UK and the EU and weaken the UK's attractiveness as a gateway or platform for non-EU multinational companies and investors for expansion in the EU. In certain scenarios (most notably the Norwegian and the Swiss scenario) the UK may be able to retain access to the Parent Subsidiary Directive and the Interest and Royalty Directive or an equivalent arrangement, however, in return the EU would likely ask important concessions from the UK.
Termination of the Merger Directive with respect to the UK upon the Brexit means that capital gains upon a cross border reorganization involving UK and EU companies may become taxable in the UK and in the EU respectively.
Anti-Tax Avoidance Directive
The Anti-Tax Avoidance Directive ("ATAD") aims to combat the alleged improper use of tax rules by multinational companies, for instance by setting minimum standards for CFC rules and interest deduction limitations. Most rules included in the ATAD will effectively enter into force on 1 January 2019.
Post Brexit situation
Once the UK has left the EU, it has in principle no obligation to apply the ATAD rules. However, some of the rules included in the ATAD reflect to a certain extend what has been agreed at OECD level in connection with the Base Erosion and Profit Shifting ("BEPS") project. The United Kingdom is an OECD Member State. Therefore it is reasonable to assume that the United Kingdom will implement certain elements of the ATAD to the extent that these correspond with the BEPS project.
- Impact of Brexit on Dutch tax law
Several provisions in Dutch domestic tax law only apply to EU resident companies. As a result of the Brexit, UK resident companies would no longer be able to benefit from these provisions. In the following, we will briefly outline a (non-exhaustive) number of relevant Dutch tax provisions.
Dutch fiscal unity
The Dutch fiscal unity regime provides for tax consolidation of Dutch resident entities that are part of the same group (a 95% ownership threshold applies for purposes of the formation of a fiscal unity). The benefits of the fiscal unity regime are that profits and losses (e.g. as a result of interest on acquisition loans) can be offset and that assets can be transferred between the members of a fiscal unity free of corporate income tax.
As a result of the Papillon Case (C-418/07) decided by the ECJ, the fiscal unity also had to be allowed in the following situations:
- The top holding company is resident in another EU Member State: As a result two Dutch resident sister companies with an EU parent can form a fiscal unity; and
- There is an EU resident intermediate holding company: As a result a Dutch resident parent company can from a fiscal unity with an indirect subsidiary, the shares of which are held by an EU resident company.
These amendments to the Dutch fiscal unity regime provide multinational groups with great flexibility to have their Dutch resident entities benefit from the advantages of the Dutch fiscal unity regime.
Following the Brexit the amendments to the Dutch fiscal unity regime as a result of the Papillon Case would no longer apply to top holding companies or intermediate holding companies resident in the UK. This may necessitate UK based multinational groups to reorganize their corporate structure.
Reorganization facilities in Dutch law
Dutch domestic law provides for tax free roll-over facilities in the event of business mergers, legal mergers and legal demergers (subject to certain conditions and anti-abuse provisions). However, these tax free roll-over facilities are only applicable in the event the parties to the merger are resident in the Netherlands, the EU or the EEA.
As a result of the Brexit, UK companies would in principle no longer be able to benefit from these tax free merger and demerger facilities.
Dutch dividend withholding tax
The Dutch domestic Dividend Withholding Tax Act ("DWTA"; Wet op de dividendbelasting 1965) provides for an exemption from Dutch dividend withholding tax in respect of distributions to EU or EEA resident corporate shareholders that hold an interest of 5% in the Dutch resident entity making the distribution. The benefit of this statutory exemption is that it applies automatically, whereas a 0% rate under an applicable tax treaty concluded by the Netherlands is by default effectuated through a refund procedure (unless a certificate has been granted by the Dutch tax authorities allowing for an exemption of withholding).
Furthermore, the Dutch DWTA provides that EU and EEA resident pension funds (and other tax exempt entities) are eligible for a full refund of Dutch dividend withholding tax, under the same conditions as Dutch pension funds (and other Dutch tax exempt entities).
As a result of the Brexit, UK corporate shareholders would no longer qualify for the automatic exemption from Dutch dividend withholding tax, but would have to apply for an exemption certificate under the double tax treaty concluded between the Netherlands and the UK (the "NL-UK DTT"), which provides for a 0% rate, albeit that this only applies in respect of shareholdings of at least 10%.
Furthermore, although UK pension funds would – after the Brexit – no longer be eligible for the Dutch domestic dividend withholding tax refund procedure, the NL-UK DTT provides for a 0% rate for dividends distributed by Dutch resident entities to UK to qualifying UK pension funds. This would, however, not apply for certain other tax exempt entities.
- Concluding remarks
If the UK decides to indeed go ahead with the Brexit and submits the Article 50 Notice, complex and heated negotiations on the terms of the new relationship between the UK and the EU can be expected. The negotiators will have the Herculean task of balancing a plethora of opposing political and economic interests of the UK, the EU and, importantly, the interests of the 27 remaining individual EU Member States. Access of the UK – in some shape or form – to the EU Single Market will come at a price and the question is which price the UK will be willing to pay, given the strong sentiments underlying the Brexit vote. The tax chapter of the negotiations will no doubt be heavily debated. UK Chancellor Osborne’s announcement of a substantial further reduction of the UK’s corporate income tax rate means that the UK is positioning itself to do battle for the favors of international investors. On the other side of the Channel, EU Member States such as France and the Netherlands are marketing themselves as jurisdictions of choice for companies considering to leave the UK.
Against this background, it may prove difficult for the UK to try and maintain the benefits of the current EU tax arrangements – at least not without giving substantial concessions in return (e.g. acceptance of the State Aid prohibition, compliance with the EU Code of Conduct on harmful tax competition and the EU fundamental freedoms). Having said this, not each and every of such tax benefits is dependent on access of the UK to the EU arrangements as bilateral tax treaties – assuming these would remain applicable - may in some cases provide a viable alternative (e.g. with respect to reduction or exemption from withholding taxes).
The UK government's delay in submitting the Article 50 Notice provides multinational businesses and investors with a window to analyze the impact of various scenarios and plan for adjustments to their organizations to soften the tax impact of the Brexit.