Q&A: What ‘Brexit’ could mean for the UK tax system

What is the issue here?

For more than 40 years, Europe has arguably been the single biggest influence on the UK tax system. The Conservative government’s election manifesto promised ‘real change in our relationship with Europe’, including reform of the workings of the EU, reclaiming power from Brussels, safeguarding British interests in the single market and, to crown it all, an in/out referendum by the end of 2017. If the result of the referendum is that the UK will leave the EU, what would be the implications for the UK tax regime? The likely outcomes are difficult to predict, not least because the terms of any future exit remain unclear.

What will have to change?

VAT: If the UK leaves the EU, it will no longer be required to give effect to the VAT Directive and so will no longer have to require UK businesses to charge, and pay, VAT on domestic supplies of goods and services.

However, because VAT constitutes a large proportion of the UK government’s annual tax revenue (21% in 2013/14), it is unlikely that the government would repeal it without replacing it with a new UK sales tax. A UK government unconstrained by the VAT Directive would have more flexibility as to the rate of a new UK sales tax. It could, for example, set its own rates and determine the types of goods and services subject to each one.

Even if it wished to, it is unlikely that the government could apply the current VAT rules to a UK sales tax without modification. Whatever modifications are pursued, UK businesses transacting with suppliers or customers in EU member states are likely to face increased costs as a result of applying different systems.

There is also a question about the extent to which existing and future EU jurisprudence, including decisions of the CJEU, would assist in interpreting the law applicable to the UK sales tax. Presumably, for periods before Brexit, decisions of the CJEU would remain binding, but the position is less clear after withdrawal.

Parent-Subsidiary Directive: After Brexit, it will no longer be required to give effect to the Parent-Subsidiary Directive. Broadly, this provides that, where a parent company in one EU member state receives distributions of profits from a subsidiary company in another member state, the member state of the parent company must not tax the receipt.

Once the Parent-Subsidiary Directive no longer applies, a group of companies with a parent company in the UK and subsidiaries in an EU member state, or with a parent company in a member state and subsidiaries in the UK, may become subject to double taxation in respect of profit distributions unless a double tax treaty or similar arrangement prevents this. In fact, the UK is one of the jurisdictions that has concluded the most double taxation agreements, including with all current members of the EU.

Merger Directive: The UK will also no longer be required to give effect to the Merger Directive, which is designed to remove fiscal obstacles to cross-border reorganisations. In the case of mergers involving a company transferring assets and liabilities to one or more companies in a different EU member state, the Directive provides for a deferral of the taxes that could be charged on the difference between the real value of such assets and liabilities and their value for tax purposes, subject to certain conditions.

What may change?

State aid: Assuming the UK is no longer part of the EEA and does not join EFTA or enter into similar arrangements with the EU, it will no longer be subject to EU law restrictions when seeking to grant state aid. The corollary of that, however, is that it will no longer have any recourse through the EU against member states introducing state aid that disadvantages UK businesses.

Capital Duties Directive: It will also no longer be required to give effect to the Capital Duties Directive. This prevents, in some instances, EU member states charging indirect tax in respect of the raising of capital by companies (for example, by issuing shares or other securities).

UK legislation currently imposes a 1.5% SDRT charge on issues of shares and securities to depositary receipt issuers and clearance services in certain circumstances. However, as a result of the Capital Duties Directive and decisions of the CJEU and First-tier Tribunal, HMRC announced it would no longer seek to impose this charge. If the UK left the EU, and assuming it did not enter into similar arrangements with EU member states, the government would be free to impose this SDRT charge. If it wished, it could also impose a new capital duty.

Are there any other areas of incompatibility with EU law?

In the past, the CJEU has declared UK tax legislation to be incompatible with EU law and required such legislation to be amended. After Brexit, UK tax legislation would no longer be open to challenge on the basis that it is contrary to EU law.

What is likely to stay the same?

Brexit is unlikely to have a material effect on property related taxes, including SDLT, the new non-resident CGT on dwellings or the annual tax on enveloped dwellings. And we will probably still have at least one (and sometimes two) new Finance Act(s) each year!