Little changed for UK businesses from a tax perspective when the UK left the EU on January 31, 2020. Under the terms of the Withdrawal Act 2018 (as amended by the Withdrawal Agreement Act 2020), during the transition period which ran until 11pm on December 31, 2020, most EU tax law continued to apply to the UK as if it were still an EU member state. The UK continued to be within the EU VAT regime, customs union and single market and the UK courts continued to be able to make references to the CJEU. From January 1, the UK has moved out of the transition period into a new relationship governed by the terms of the Trade and Cooperation Agreement (the “TCA”).
The Withdrawal Agreement Act includes a Protocol on Ireland/Northern Ireland, which sets out the arrangements required to avoid a hard border in Ireland. This provides that Northern Ireland will remain part of the UK's customs territory and the UK's VAT area but also requires Northern Ireland to remain aligned to EU single market and customs rules (for goods, but not services).
VAT - how will Brexit affect VAT?
The legislation implementing VAT in the UK is a mixture of European and domestic and much of the case law derives from litigation in the domestic courts of other EU member states. VAT accounts for around a fifth of the UK’s tax revenue and the Government confirmed early on that the UK would continue to run a VAT system after it left the EU in substantially the same form and has now implemented secondary legislation where necessary to enable this. UK VAT law as it applies to UK (rather than cross-border) activities is likely to continue to apply in its current form initially, with the potential for some specific changes, e.g. on the scope of zero and reduced rates.
The UK as a Third Country
The key immediate change is due to the UK’s new status as a third (i.e. non-EU) country. VAT treatment of imports of goods from EU member states are now aligned with those from outside the EU which means that UK VAT will be imposed on imports from the EU. UK VAT registered importers should be able to take advantage of ‘postponed accounting’ – which means that this import VAT will be included and paid by reference to the next VAT return in order to assist with cash flow timing. It is unclear whether EU member states will provide the same assistance for customers importing from the UK.
As widely anticipated, there are also implications for access to a number of EU-wide VAT simplification measures such as the mini one-stop shop (“MOSS”, a way for a business supplying certain digital services to non-business EU customers to pay VAT without having to register in each member state the customers are located in), direct selling thresholds and the EU VAT refund system.
For UK businesses engaged in UK/EU cross-border sales, the planning measures suggested in the no-deal scenario remain relevant: new EU VAT registrations (and appointment of VAT fiscal representatives if needed); ensuring familiarity with relevant VAT refund mechanisms operated by member states; getting up to speed with requirements for postponed accounting for import VAT; and, if engaged in digital sales, applying for a MOSS registration in an EU member state.
VAT – what changes will be made?
Some changes will be made to the UK system to reflect the equivalence of treatment for EU and non-EU customers.
This includes regulations which have been made allowing deduction of input VAT attributable to certain financial and insurance services supplied to EU customers, enabling recovery of previously irrecoverable VAT.
It is unclear whether further changes will be made. EU law was incorporated into UK law with effect from 11pm on 31 December 2020 (the end of the implementation period). Historic decisions of the CJEU in relation to retained EU law, generally, remain binding on the UK courts and tribunals unless overruled by the Supreme Court or Court of Appeal or equivalents in Scotland and Northern Ireland or, in certain situations, other specified appellate courts and tribunals (‘relevant courts’). Within these constraints, and subject to the ongoing commitments outlined in the TCA, the UK is entitled to amend its VAT regime. The UK is undertaking consultations on the future treatment of financial services and funds which may indicate areas that the UK is considering making changes to.
Corporate tax and groups - should we expect further changes to UK corporate taxation in light of Brexit?
Direct taxes (corporation tax, PRT, income tax, capital gains tax, NICS, IHT, stamp taxes) are outside the competence of the EU but, due to EU law enabling EU legislation for furthering the functioning of the internal market, there are a few important direct tax directives.
The loss of benefits conferred by the EU Parent-Subsidiary Directive and the Interest and Royalties Directive may bring changes to the withholding tax treatment of interest, royalties and dividends paid between the UK and some EU group companies. Within the EU, EU law (broadly) prevents interest, royalties and dividends paid intra-group between EU companies from being subject to withholding tax. The UK Government confirmed during the implementation period that it will preserve this position under domestic legislation for payments made from a UK company to an EU recipient. However, there is no obligation on EU member states to reciprocate for payments made to the UK. Where there is no specific domestic legislation providing relief, the position under the relevant double tax treaty will apply and treaty claims need to be made for full or partial exemption under the relevant treaty. This means that, for example, payments from an Italian subsidiary to a UK parent, which previously relied on the Parent-Subsidiary Directive to be free from withholding tax, may now suffer withholding at 10 per cent. It also means that treaty claims have to be made even if the treaty provides for zero withholding. Businesses which have not already done so should check the withholding tax position for cross border income flows between group companies and make sure the necessary claims have been made.
Another question for cross-border payments is whether UK shareholders qualify as ‘equivalent beneficiaries’ for the purposes of the limitation on benefits test in many US tax treaties. This test, in broad terms, extends treaty benefits to a treaty state resident which would otherwise fail the limitations on benefits clause, if its non-resident shareholders would have been entitled to benefits had they received the income direct. These ‘equivalent beneficiaries’ must be EU, EEA or NAFTA members, a status U.K shareholders no longer have. Absent US concession, there may be implications for companies relying on the status of UK shareholders in order to benefit from tax treaty relief in relation to the US. Competent authority agreements between the US and UK released on 28 July 2021 provide that the UK will continue to be regarded as an EU member state for the purposes of the equivalent beneficiaries definition under the US/UK double tax treaty. This means that a UK resident company which would not otherwise meet the limitation on benefits test in the US/UK treaty will be able to continue to include UK shareholders in calculating whether the necessary threshold for ownership is met. However, it does not address the more common situation where non-UK companies rely on the status of UK shareholders to meet the limitations on benefits test under the relevant US double tax treaty as that would require amendment to the definition of equivalent beneficiary under the terms of that double tax treaty with the US.
The UK’s corporation tax system is domestic, albeit with European influences. Following the CJEU decision in Marks and Spencer v Halsey, the UK has had to allow cross-border loss relief, so as not to restrict taxpayers’ freedom of establishment. Similarly, group relief claims have, since the Finance Act 2000, been permitted in respect of UK-resident subsidiaries of an EU parent. It would now be open to the UK to consider legislating to remove cross-border loss relief, but it is less likely that the ability to form intra-UK groups where there are non-UK shareholders will be affected.
There had been speculation that the UK may move to make its regime more competitive. Whilst the terms of the TCA limit the UK’s ability to diverge from standards designed to promote a ‘level playing field’, they do not appear to prevent the UK from moving in that direction as long as measures introduced do not amount to subsidies or contravene OECD guidelines or standards.
Tax transparency - ongoing commitments and the significant limitation on the scope of DAC 6
The TCA contains commitments in relation to tax good governance and, in particular to global standards on tax transparency, exchange of information and general administrative cooperation, and principles of fair tax competition. It is accompanied by a number of Joint Political Declarations including a stand-alone Joint Political Declaration on Countering Harmful Tax Regimes which sets out political commitment to the principles of countering harmful tax regimes, and reflects the work done by the OECD under Action 5 of the BEPS Action Plan.
One major development is in relation to DAC 6, the new EU mandatory disclosure regime requiring reporting of cross-border arrangements where hallmarks intended to be indicative of aggressive tax planning are identified.
The UK Government has very significantly restricted the scope of the DAC 6 regime in the UK so that only arrangements falling within Hallmarks D1 or D2 are retained. This removes from the UK regime the hallmarks which had caused most concern and difficulty and means, broadly, that only arrangements which have the effect of undermining or circumventing Common Reporting Standard (CRS) reporting or obscuring beneficial ownership will be reportable. The retention of this limb of the regime reflects the UK’s commitment under the TCA to implement the OECD minimum standards against BEPS (here, specifically, the OECD’s Model Mandatory Disclosure Rules for CRS Avoidance Arrangements and Opaque Offshore Structures).
The perhaps even better news from a compliance perspective is that, whilst DAC 6 provides for reporting of arrangements from June 25, 2018, HMRC have confirmed that the restriction in reporting scope will also apply to these historic arrangements. It seems likely that HMRC have been able to reach this conclusion on the basis that the reporting obligations had not come into effect before January 1, 2021 and the actual reporting obligation in the regulations (as now amended) only picks up the D hallmarks. This means that, in effect, very little reporting is likely to be required under the UK regime. Of course, the fact that no reporting is required in the UK does mean that reporting requirements under the domestic regimes of EU member states do not need to be considered.
European tax litigation – how will Brexit affect EU tax law litigation?
Over the last fifteen years, we have seen significant litigation based on the incompatibility of the UK’s historic tax code with European law (more specifically, with the fundamental freedoms). Where UK provisions have been held to be unlawful by the CJEU (triggering payments of compensation), the effect of Brexit on (a) historic and (b) pending litigation will need to be considered. Following Brexit, the UK Parliament may consider whether it wishes to pass fresh legislation in respect of these multi-billion pound claims; whereas previous attempts to do so have themselves been subject to challenge under European law, post-Brexit legislation would not face this particular hurdle. However, recent Supreme Court decisions have considerably restricted the scope of any claims and the quantum of damages available.
There will be no more references by UK Courts to the CJEU and future CJEU decisions will be considered by UK courts on a discretionary basis. UK courts will not be bound by any principles laid down or any decision made by the CJEU after January 1, 2021. Retained EU case law will be binding on courts other than those identified as ‘relevant courts’ (discussed above).
Nonetheless, the Withdrawal Act potentially maintained the status quo in respect of challenges to the validity of retained EU law and failure to comply with EU law for tax litigation proceedings if:
- begun, but not finally decided, before January 1, 2021, or
- begun within three years of December 31, 2020 if they involve challenges to anything which occurred before exit day unless the challenge is for the disapplication or quashing of an Act of Parliament or rule of law. The three year time limit is reduced to two years for Francovich damages claims for failure to implement EU law.