Does the United Kingdom’s vote to leave the European Union change the United Kingdom’s attractiveness as a holding company jurisdiction?
On 23 June, the UK referendum on whether or not to stay in the EU resulted in a “leave” vote (Brexit). The process of leaving the European Union will take some time (expected to be at least two years), and in the meantime, the United Kingdom remains part of the European Union and subject to the EU treaties in the normal way. However, it is prudent for multinational groups to consider what the implications of the UK leaving the EU may mean from a tax perspective; there is a degree of speculation involved here because there are several potential options for the future. We have considered below whether the United Kingdom is likely to remain competitive for a jurisdiction to base holding companies from a tax perspective. Many of the United Kingdom’s non-tax advantages, including a qualified workforce and, of course, the English language, should remain unchanged.
It is important for a holding company to be able to receive payments from subsidiaries and to make payments to shareholders or a parent company in a tax-efficient manner. UK companies benefit from a number of advantages in this regard, including the following.
Although some aspects of these rules (including, in particular, the recent amendments to the CFC rules) were triggered by decisions under EU law at the European Court of Justice, the rules are now enshrined in UK tax law. After leaving the European Union (and depending on how that exit is implemented), the United Kingdom will in principle be free to amend tax law, or undo prior amendments, in a way that would no longer be consistent with the fundamental freedoms of the European Union with which the United Kingdom is currently obliged to comply. However, history demonstrates that when the United Kingdom has introduced changes in a way to comply with EU rules, it has not typically done so in a way that differentiates EU members from non-EU members. Recent governments have been very keen to demonstrate that the United Kingdom is a good place to situate international businesses and there is no reason to think this drive will now change.
If the United Kingdom is used as a holding company jurisdiction, it is also important that the subsidiaries can make payments to the United Kingdom in a tax-efficient manner. Many European jurisdictions impose withholding on dividends, interest, and/or royalties. While the United Kingdom is a member of the European Union, it can rely on both the parent subsidiary directive (enabling dividends to be paid without withholding to a 25% parent) and the interest and royalties directive (allowing interest and royalties to be paid without withholding to an associated company—being a direct 25% parent or a sister company with the same direct 25% parent), subject to such holding period requirements that the paying jurisdiction may have imposed.
Should the United Kingdom cease to be able to benefit from these directives (which is not a given, even when it leaves the European Union—see below), such group companies will need to fall back on the treaty network to eliminate or reduce withholding (or rely on other domestic law exemptions from withholding tax). The United Kingdom has a tax treaty with each member of the European Union, each of which contains a non-discrimination clause. In some cases, the withholding tax on dividends is reduced but not eliminated under the relevant treaty, including (without limitation) 5% from French, German, Irish, and Luxembourg subsidiaries and 10% from Spanish subsidiaries. On the other hand, many of the treaties with EU jurisdictions permit dividend payments to group companies without withholding, including Belgium and the Netherlands. Similarly, many of the treaties eliminate withholding on interest and royalties. The cost of any additional withholding tax on payments from subsidiaries to the United Kingdom would need to be weighed against the likelihood of withholdings directly from EU companies to non-EU parents.
Furthermore, the EU Parliament has very recently called for an EU-wide withholding tax on all payments leaving the European Union. If that were enacted with the United Kingdom as a member of the European Union, the United Kingdom would be obliged to introduce withholding on dividend payments. But if the United Kingdom has already left the European Union, there would be no need to introduce such an additional tax.
The United Kingdom has been an active participant in the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting project (BEPS). Indeed, the United Kingdom has already (unilaterally) started to introduce and consult on rules designed to address BEPS. Although the European Union is also an active participant, it seems unlikely that the United Kingdom’s commitment to BEPS will continue unabated, and any changes to the UK tax legislation resulting from BEPS are not expected to be influenced by the United Kingdom leaving the European Union. One area of focus is transfer pricing. The United Kingdom has for some time had domestic rules that expressly adopt OECD principles. Although it is impossible to predict the future, it seems likely that the United Kingdom will continue to be actively involved in BEPS and to adopt its principles, including any changes to the transfer pricing rules.
The United Kingdom’s patent box rules have recently been considerably limited (with effect on a transitional basis from 1 January 2016) to comply with EU rules. Such restrictions may be reversed once the United Kingdom is no longer required to comply with the EU rules, although it would be prudent to assume no such changes will be introduced. Similarly, as a result of EU case law, the United Kingdom has been required to extend the availability of relief for losses in overseas branches. Again, it is possible—but by no means certain—that once the EU rules no longer apply, the loss relief rules will be restricted again, unless the United Kingdom joins the European Economic Area (EEA) (see below).
For some time now, the European Union has been discussing the common consolidated corporate tax base (CCCTB), which would result in all EU companies broadly being required to calculate taxable profits using the same principles, with states being restricted to setting tax rates only. Any such change would require unanimity across the European Union, and the United Kingdom has been openly opposed to the CCCTB. The UK leaving the EU may open the door to the remaining states to adopt a CCCTB, which would represent fundamental tax change and upheaval in many states.
VAT
One area where we may (in due course) see real change is in value added tax (VAT). VAT is incorporated into domestic UK law through the Value Added Tax Act 1994, but it is fundamentally an EU tax. The structure and most of the fundamental principles of the VAT code are dictated by EU law, so the UK leaving the EU would, in theory, give the United Kingdom the freedom to alter various aspects of the VAT regime (assuming that it does not elect to repeal VAT altogether, which we believe is an extremely unlikely outcome, given that VAT accounted for 22% of all UK taxes raised in 2014/15), including the following.
Because VAT is a territorial tax that focuses on the jurisdiction in which goods or services are consumed, in many cases, the UK leaving the EU should not, at least in the short term, materially affect the VAT liabilities of businesses. Following Brexit, it is unlikely that the United Kingdom would take steps to significantly reduce the VAT yield (for example, by making substantial reductions to the standard rate) which, for the 2016–17 fiscal year, is estimated to be £124 billion. However, certain business—particularly those in the digital arena, such as electronic marketplaces and telecommunications providers—may notice changes because they currently benefit from specific rules applicable only to businesses located in the European Union that simplify compliance.
In the longer term, it seems likely that UK and EU VAT law will diverge. The European Commission is currently consulting on changes to the place of supply rules in relation to its Digital Single Market initiative; such changes would not be implemented in the United Kingdom without positive action from the then-government, and at a domestic level, it seems likely that the United Kingdom would make changes to the UK-VAT regime to stimulate consumption and meet domestic policy objectives. However, whilst this may increase compliance costs, it may also result in VAT advantages for businesses because the United Kingdom would gain flexibility to make targeted changes in areas such as the recoverability of VAT and the items on which it is charged and the applicable rates.
Customs Duty
In addition to guaranteeing the free movement of people, the European Union operates as a customs union with no custom duties imposed on transactions within it. In relation to customs duty, the UK’s departure from the EU may have a more immediate impact. The United Kingdom is currently a member of the European Customs Union (the Customs Union), which includes other EU member states as well as jurisdictions, such as Andorra and Turkey. Members of the EEA and European Free Trade Association (EFTA), such as Norway and Switzerland, also participate in the Customs Union indirectly by virtue of free trade agreements. The movement of goods between member jurisdictions does not attract customs duty (or tariffs)—the principle being that goods are charged to duty once on entry into the Customs Union. On Brexit, the United Kingdom will lose access to the Customs Union unless it is able to negotiate a free trade agreement or it joins the Customs Union.
Financial Transactions Tax
For some time, various EU member states have been discussing a financial transactions tax (FTT) that would apply to certain (wide-ranging) transactions in securities that involve an issuer or a counterparty in one of the participating member states. The United Kingdom is not currently one of the states participating and has no role in this process. Nothing will change in this regard; because the FTT has such wide potential application, it could apply to deals involving UK issuers or counterparties in the same way whether or not it remains in the European Union.
Whilst the United Kingdom has clearly voted to leave the European Union, it is less clear what relationship the United Kingdom will have in the future with the European Union and the legal basis of that relationship. The approach taken may also materially affect the United Kingdom’s tax system. There are various precedents that may be followed, which other European countries that are not EU members (such as Switzerland and Norway) have entered into.
EEA Membership
If the United Kingdom opts to join the EEA (28 EU members, such as Norway, Iceland, and Liechtenstein), then the United Kingdom would not be subject to the EU legislation on home and foreign affairs, justice, and taxation. However, EEA members are still subject to the EU legislation relating to the single market, which includes the fundamental freedoms: the movement of people, freedom of establishment, and freedom of goods/services. This outcome is likely to result in little change in terms of UK tax law, as many of the UK tax provisions influenced by EU law were based on these fundamental freedoms (i.e., giving UK tax relief for foreign branch losses—based on freedom of establishment).
EFTA Membership
There is substantial overlap between the membership of the EEA and EFTA—the latter additionally includes Switzerland. EFTA is a much looser association than both the EEA and the European Union; the members are not bound by any existing EU legislation. EFTA membership would allow for free trade in goods and, to some extent, services. It also would allow for free movement of capital and persons, but the rights are not as extensive as the equivalent EU rights and are additionally restricted in certain instances (e.g., Switzerland did not allow EFTA nationals to immigrate as a right, but subsequently agreed to do so in a bilateral arrangement with the European Union from 2008).
From a tax perspective, if the United Kingdom joined (technically re-joined, because it was an EFTA member before it joined the European Union) EFTA, then it should have materially more freedom over the shape of existing and future UK tax legislation.
Ad Hoc Bilateral Agreements
Switzerland has opted to enter into a variety of agreements that, in principle, shelter it from respecting all EU rules and requirements. In particular, Switzerland is in effect bound by, and can benefit from, both the parent subsidiary directive and the interest and royalties directive. As a practical matter, to preserve trade with the rest of Europe, Switzerland has agreed to adopt a number of EU equivalent measures.
Customs Union
If the United Kingdom were simply to agree to a customs union that allows for tariff-free trades of goods with the customs union (and perhaps tariffs directed by the European Union for non-union states), in principle, it would not be required to adopt EU rules. However, as a practical matter, it is possible that the European Union would require adoption of certain measures to agree to the customs union without having been involved in shaping such measures.
The UK tax rules relied on for effecting cross-border deals in a tax-efficient manner generally do not rely on the EU rules or fundamental freedoms and so should be able to continue with the same tax implications.
It is conceivable that the United Kingdom will reverse a recent change in practice that prevents stamp duty reserve tax (SDRT) from applying to certain issues or transfers of UK securities to clearing systems and/or depositary receipts. The United Kingdom currently does not enforce SDRT in these circumstances as a result of some cases heard by the European Court of Justice, but never actually repealed the legislation. Hence, it may be an easy practice to reverse if and when compliance with EU principles is no longer required.
Some documentary changes may be required, for example, redefining VAT if it has been defined by reference to the EU rules, but we expect these to be minimal.
UK financial institutions are required to report tax-related information on account holders under the Foreign Account Tax Compliance Act, “CDOT FATCA” (with the United Kingdom’s Crown Dependencies and Overseas Territories, due to be repealed in any event as it has been replaced with the common reporting standard), the Common Reporting Standard (as introduced by the OECD; the CRS), and the EU-wide Directive for Administrative Cooperation (DAC). Although the DAC would cease to apply to the United Kingdom once it leaves the European Union, each member state has in any event already signed up to the CRS, and the DAC is fundamentally identical to the CRS. As a result, the obligations of UK financial institutions are very unlikely to change solely as a result of Brexit.
For more than three decades, Morgan Lewis has represented companies and institutions doing business in the United Kingdom and globally. Our Brexit team of lawyers have been advising clients on a variety of legal issues in the run up to the decision and are assessing the complex short- and long-term implications of the June 23 vote. Our Brexit Resource Centre will continue to provide guidance on the legal and business implications of the United Kingdom’s decision to leave the union. To view this alert and others, and to gain immediate access to our most recent guidance on Brexit, please visit the Brexit Resource Centre. In addition, please feel free to speak to your usual contact at Morgan Lewis or to contact any one of the Brexit Team via Brexit@morganlewis.com.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
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Kate Habershon
Neil McKnight