More than three months after the initial shock of the Brexit vote, the financial markets and the political environment seem to have stabilized.
The vote’s initial impact on the UK economy seems to have been limited. However, as the challenges ahead of us start to become clearer, it is worth remembering this is only the beginning of a very long journey.
The tax implications of Brexit will be substantial, with the consequences being felt beyond the UK and the EU. Businesses will need to understand and be able to respond to changes in the tax landscape that are likely to be unprecedented in terms of both volume and speed of implementation.
To do so, it will be crucial for companies to closely monitor and assess the Brexit process as it unfolds. This will enable companies to plan effectively for both the short and long term.
Where are we now?
The referendum result had an immediate impact on both the economy and the political landscape in the UK.
Although the consensus is that the UK economy will slow down as a result of the Brexit vote in the short- to medium-term, it has so far proved more resilient in the immediate aftermath than many economists had anticipated. The Organisation for Economic Co-operation and Development (OECD) recently revised upward its forecast for growth this year as a result of a stronger-than-expected performance in the first half of 2016 and action taken in August by the Bank of England to spur activity.
The OECD said it expects the UK economy to grow by 1.8% this year, a 0.1 point increase on its pre-referendum estimate, but then fall by more than it had previously envisaged, and grow by 1% in 2017. The output of the services sector — the steam engine of the UK economy — as well as retail sales seem to be holding strong.
Overall, while the gloomier predictions around the Brexit vote are unlikely to be realized, the economy is not out of the woods yet, and the long term impact of the Brexit vote on both the UK and global economies remains uncertain.
The immediate political fallout from the vote saw the departure of many of the senior figures of the Remain campaign (the resignation of David Cameron and the sacking of George Osborne and Michael Gove). However, the political landscape removed additional uncertainty when the Conservative party avoided a lengthy leadership battle and a new Government under Theresa May emerged.
Who are the key players?
Within the UK, there have been changes of personnel and also changes in the institutional setup. For the tax world, the most significant change is the replacement of George Osborne, long-term Chancellor of the Exchequer under David Cameron, with Philip Hammond.
Institutionally, the big innovations are the creation of two new departments of state dedicated to delivering Brexit.
- Philip Hammond, Chancellor of the Exchequer - The new Chancellor has accepted that the Brexit vote means the economy is entering a “new phase” that will require a “different set of parameters” to reduce the deficit. As head of Treasury, Hammond will play a crucial role in shaping the tax aspects of the Brexit process.
- David Davis, Secretary of State for Exiting the European Union - He will lead and coordinate the cross-government policy work to support the UK’s negotiations to leave the EU. This will include handling the negotiations with the EU and bilateral discussions with other European countries.
- Liam Fox, Secretary of State for International Trade - He will be responsible for developing, coordinating and delivering a new trade and investment policy for the UK. This includes developing and negotiating free trade agreements and market access deals with non-EU countries, multilateral trade deals and providing operational support for exports, as well as inward and outward investment.
At an official level, we have also seen the setting up, within the key tax departments (HM Treasury and HM Revenue & Customs), of dedicated units responsible for managing the Brexit transition.
Beyond the UK, the key players in the Brexit process will be the leaders of France and Germany and the Presidents of the various EU institutions (the Council, the European Commission and the European Parliament).
What happens next?
Formal withdrawal talks will only be triggered when Britain invokes Article 50 of the Lisbon Treaty, which puts other EU leaders on notice that the UK intends to leave.
The UK will have up to two years from when it invokes Article 50 to negotiate its separation from the EU. Prime Minister May has signaled that this will not happen until early 2017.
What would change in the tax environment?
While the extent of change cannot be predicted with any certainty at this stage, there is a range of areas where Brexit could result in significant changes in tax and tax policy.
- Customs and excise: As a current member of the EU, the UK applies the Common Customs Tariff to goods entering the UK from outside the Union. This is managed by the EU itself and so, if the UK wished to continue charging tariffs on imports, it would need to legislate for a domestic tariff system.
Excise duties are not fully harmonized in the EU, and the UK would be able to maintain its present system.
- VAT: It is likely that the UK will largely retain the current system of value-added tax (VAT) on leaving the EU, particularly since VAT is directly enacted into UK law. However, taxpayers would no longer have a right of appeal to the Court of Justice of the European Union, and the UK Government would have additional flexibility on setting the rates and scope of VAT.
- Withholding tax: UK groups would no longer be able to benefit from the withholding tax exemptions in the EU Parent-Subsidiary Directive and the Interest and Royalties Directive once the UK leaves. Not all existing UK tax treaties provide for a zero withholding tax; as a result, the updating of the tax treaty network is expected to be a high priority for these companies, which may wish to review where they rely on EU directives to mitigate withholding tax.
- Treaties: Many treaties between the US and EU Member States require EU membership for equivalent beneficiary treatment under the limitation of benefits clause of the treaty, a test which, once there has been a formal exit, the UK would no longer meet. This may affect those groups that have a UK tax resident-listed ultimate parent and flows of interest, dividends or royalties from their US subgroup to a financing, holding or intellectual property-owning company in Europe.
- Labor mobility: At present, the rules governing where mobile workers pay their social contributions and how their entitlement to social security benefits are aggregated are coordinated at the EU level. If the EU migrant worker regulation did not apply to the UK, employers sending workers cross-border would need to navigate a complex network of bilateral agreements.
- State Aid: The EU’s State Aid rules may no longer apply to the UK after it leaves. This may affect the development of ongoing investigations, and direct tax measures that in the past were found to constitute State Aid may be revived in the medium term.
- EU tax initiatives: Subject to the terms under which the UK leaves the EU, it is unlikely that the UK will be party to various tax initiatives currently in progress in Brussels, such as the EU Anti-Tax Avoidance Directive, public country-by-country reporting and the common consolidated corporate tax base. However, where the UK has supported these initiatives, we would expect the UK to continue to push ahead with similar legislation.
What should be your key priorities?
The impact of Brexit on companies will depend on the extent of their business relationships with the UK. But even those companies with a tangential relationship with the UK may be affected.
Key areas that deserve special attention to assess the impact of Brexit are the following:
The dashboard below summarizes some of the key questions that will be important to address in assessing the impact of Brexit on individual businesses.
What to do now?
None of the questions above have a straightforward answer. The next couple of years will be crucial to assessing the impact of Brexit on companies and their employees.
We are seeing companies plan for the future, but they need to avoid preempting the decisions that will follow from both the UK and the EU. The key actions now are the following:
- Evaluate the potential risk areas
- Consider the timeline for those risks
- Develop an outline plan for responding to the risks
- Identify the triggers for action
- Monitor developments
All of this spans far more than tax alone, and leading companies are ensuring that the tax team is embedded in their Brexit steering committees. The vote on 23 June was only the starting point, and where the finish line leads is not yet known.
This article is included in issue 18 of EY´s Global tax policy and controversy briefing.