IN BRIEF

Tax Implications of a No-Deal Brexit

Sept. 28, 2020

London

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The current prospect that no trade agreement with the EU will be reached before the transition period’s year-end deadline will mean probable supply disruptions and other fallout for the British economy. Even with an eleventh-hour shift in the deadlocked negotiations, multiple other factors coming into play will force significant change on U.K. companies.

When did Brexit come into force and what is the “transition period”?

The withdrawal treaty under which the U.K. ended its membership in the EU on Jan. 31, 2020, included a transition period extending to Dec. 31, 2020, during which existing terms of the relationship would stay in place and negotiations with Brussels would continue to determine what the structure will look like beginning Jan. 1, 2021.

The U.K. terminated its EU membership roughly 3 1/2 years after holding a referendum on the matter, on June 23, 2016, which culminated a period of intense parliamentary standoff, even within the governing Conservative Party, over the U.K.’s relationship with the EU.

The vote, called by Prime Minister David Cameron, came after a protracted series of negotiations in Brussels on details of the U.K. membership, centering, among other things, on immigration, regulatory compliance, and cost to the U.K. The U.K. had never adopted use of the euro, with the pound sterling remaining the national currency managed by the Bank of England.

To date, the U.K. and the EU have not reached agreement on a trade deal to govern their relationship after the end of the transition period.

What is the difference between a “deal” and a “no-deal” Brexit?

The least disruptive outcome of the transition period negotiations could be for the U.K. to secure a free trade agreement with the EU. That would mean the existing trade relationships between the U.K. and the EU generally remain in force.

If agreement on a trade deal is not reached, the U.K. will be faced with trading with the EU on World Trade Organization terms and putting into place a series of trade deals with non-EU countries whose trade with the U.K. would previously have been subsumed under the EU administrative structure (though various trade deals are expected to roll over and continue to take effect). The no-deal scenario holds potentially significant ramifications for the U.K. economy because of possible supply chain interruptions, goods shortages, and other related fallout.

The withdrawal treaty left open the possibility of extending the transition period if the U.K. and the EU agreed to an extension by June 30, 2020. However, that deadline has now passed. The talks remain at loggerheads, over issues including fishing rights and “level playing field” commitments, such as the future use of state subsidies. Time is running out to reach an agreement because of the time needed to draft and ratify the document ahead of Jan. 1, 2021.


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What are the direct tax implications of a no-deal Brexit?

The direct tax implications of a no-deal Brexit are limited in that the EU generally has no jurisdiction over direct taxation. There are, however, a number of tax-related EU Directives implemented by the U.K. These include the Parent-Subsidiary Directive and the Interest and Royalties Directive, which provide exemptions from withholding tax on the payment of dividends, interest, and royalties made between companies in different EU Member States.

In relation to U.K. outbound payments, a no-deal Brexit should make little difference because U.K. domestic legislation reflecting the Parent-Subsidiary and Interest and Royalties Directives will continue to provide an exemption from withholding tax for dividends, interest, and royalties paid to companies in the remaining EU Member States.

In respect of inbound payments of dividends, interest, and royalties to the U.K., the situation will become more complex, however, as in the absence of any agreement individual EU Member States will no longer be bound by the Parent-Subsidiary Directive or the Interest and Royalties Directive so far as the U.K. is concerned. The treatment of dividends, interest, and royalty payments from companies in the EU will therefore depend on the governing domestic laws and whatever is stipulated in any existing income tax treaties between individual Member States and the U.K. The U.K. has income tax treaties with all 27 EU Member States, but a number of those treaties, for example with Germany and Italy, do not provide the same level of benefits as are available under the governing EU directives.

U.K. legislation implementing the mandatory disclosure of reportable cross-border tax planning arrangements under the EU’s DAC6 directive is expected to remain in place in a no-deal environment, although a report from HM Treasury published in January 2020 reserves the right to change this position in the event of a no-deal scenario.

What are the indirect tax implications of a no-deal Brexit?

Indirect tax effects may be more disruptive to operations because the changes that impinge on the movement of goods and services, and other administrative actions taken by the U.K. government, will have to be reckoned with.

A new border control framework was introduced in June 2020, to be implemented in three stages in January, April, and July 2021, with increasing requirements to be phased in at each stage. These measures will involve first, basic customs requirements, with duty payable on submission of customs declarations; next, pre-notification and health documentation requirements for products of animal origin and regulated plants and plant products; and finally, the requirement that businesses moving goods make declarations and pay customs duty at the point of importation.

The government also has published its new Global Tariff lists, which will come into effect Jan. 1, 2021, and will apply in those instances where no preferential agreement is in place with the exporting country.

The electronic systems previously in use for value-added tax reporting – Customs Freight Simplified Procedures (CFSPs) and Entry in Declarants Records – are expected to be available without application until June 30, 2021. CFSPs apply only to imports from the EU, and a different system may apply in Northern Ireland. Beyond June, application will be required for access to these systems. Intrastat reporting is likely to still be required.

Some relief is offered in the sphere of postponed accounting. In anticipation of Brexit, Her Majesty’s Revenue & Customs has published guidance stating that the U.K. is introducing a postponed accounting system for imports as of January 1, 2021. This system will allow VAT to be accounted for at the time of filing rather than upon importation, as it is under EU rules on “intra-Community acquisitions.”

Companies’ indirect taxation also will be impacted by existing mechanisms in individual EU countries that may – but do not always – allow postponed VAT accounting for imports. These schemes, where they are present, may or may not be available without prior application.

What key steps should U.K. businesses and their counterparties take to prepare for a no-deal scenario?

Without a Brexit deal, U.K. companies potentially face supply chain interruptions because of delayed imports of goods and services, as well as potential tax compliance difficulties and the need to adjust budgeting, cashflow, and financial management functions, depending upon their existing cross-border relationships.

U.K. companies able to do so may wish to build stocks of key EU-sourced inventory items whose supply could be interrupted because of the changeover and the resulting shipping delays. From a wider perspective, if they have not already done so, companies should evaluate all cross-border relationships for insight into the anticipated legal and regulatory framework that will apply in the new environment. Such investigation should include the effect of what will be the U.K.’s third-country status with respect to the EU, as well as the evolving framework of U.K. tax and customs law. Keeping in close touch with counterparties and suppliers in EU countries and focusing on arrangements aimed at maintaining stability of supply chains will be key.

Firms also should prepare for the added cost of adapting to accounting and reporting procedures that will be changing, irrespective of the presence or absence of a deal. Notably, there will be added expense associated with changes to freight and customs driven by the government’s so-called smart freight system (a new computer system that will require hauliers to file information electronically and receive approval before traveling toward the U.K.-EU border, to be introduced sometime after the end of the transitional period. The associated paperwork for the new system is estimated by the government to run to 13 billion pounds per year in aggregate.

Flexibility and resiliency will be critical because of the uncertainty of the endpoint. Planning for the worst-case scenario seems the best course of action, amid continuing reports of deadlock, though positions could shift as negotiations continue.


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