There is just over a year to go until March 2019, when the UK formally exits the European Union (EU). A “hard” border may be established that would separate the UK from the European single market. UK companies and foreign subsidiaries located there are readying themselves for a major change.
But this isn’t just a focus for Britain — global businesses trading with UK-EU partners will also be affected. Given the strong trade links between the UK and the EU, the likely change in this relationship will have fundamental impacts on European businesses.
“I’ve no doubt that in 10 years the UK can have a frictionless border for trade, but not within 2 years.“
Marc Bunch, EY Global Trade Leader UK and Ireland
The UK is one of the top-three export markets for 10 EU members, including Denmark, Germany, Ireland, Italy, Netherlands, Spain and Sweden, according to Brexit — the Voices of European Business, a 2017 report from the Council of British Chambers of Commerce in Europe and Hogan Lovells.
The challenge will be to be able to make trade with the UK as easy as possible, as well as look at other markets that may become relatively more competitive. That’s because Brexit-related changes could alter existing business models, with possible disruptions to supply chains, longer lines at the border, additional required documentation and higher customs duties.
While some may have held out hopes for a Brexit reversal, recent developments indicate the UK withdrawal will proceed as planned and businesses on both sides of the English Channel are preparing for change. Brexit implementation took a big step forward in early December with the UK-EU announcement that the two sides had reached a deal in which the UK will pay the EU between €40 billion and €60 billion. That clears the path for talks on trade terms between the two entities.
“Brexit is becoming more real to people and businesses in Europe, and they are finally starting to think about what they should do,” says Walter de Wit, a senior member of our Global Trade practice.
Many organizations view Brexit primarily as a tax matter — a question of how much duty they’ll pay to access the UK market or import UK goods. Both the UK and EU want to sign a free trade agreement that could set tariffs lower than the maximum rates set by the World Trade Organization or eliminate them all together, according to Marc Bunch, our Global Trade Leader UK and Ireland. (The UK and EU currently have no tariffs on imports between the two jurisdictions.)
Some European industries that are heavily reliant on UK manufacturing, including the auto, aerospace, engineering and life sciences industries, could face additional tariffs post-Brexit, according to the report Brexit — the Voices of European Business. That’s because the EU currently levies tariffs on goods and parts in which a significant component is produced outside the single market, and in the future, this could also include products that are partly manufactured in the UK.
While businesses can and should lobby officials to make clear what they would like to see in any future free trade deal, there are other questions to understand and address today. These issues will ultimately determine tax outcomes and make certain that businesses can still use their existing operations.
“The duty you’re going to pay is tomorrow’s question,” says Bunch. “There are more important questions for today, like whether you are going to be able to get goods in and out of the country come March 2019. The UK border is not going to be ready for this.”
In the pharmaceutical sector, for example, the future challenges aren’t with duties — the EU has zero most-favored nation tariffs for pharmaceutical products, according to a 2017 report from Bruegel. However, there are other non-tariff barriers that could affect the pharmaceutical industry, Bruegel noted. New types of compliance requirements and delays at the UK-EU border could make pharmaceutical products more expensive for UK residents and lead to lower trade, according to the Bruegel report.
In addition, European organizations with research and development (R&D) functions that are based in the UK could be affected by any changes to intellectual property protection arrangements between the EU and UK, according to Bruegel.
The coming negotiations between the UK and the EU on the free movement of people between the two jurisdictions also has ramifications for any European businesses conducting R&D in the UK.
“European companies have put a lot of critical research centers in the UK, and it’s going to be very important that they still have the ability to hire and retain talent,” says Paris-based Marc Lhermitte, who heads our International Location Advisory Services for the European region. “Highly skilled personnel need to have the mobility to move in or out.”
“German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit.“
Joachim Lang, Managing Director, Federation of German Industries
European businesses across all industries will need to work across many departments to handle the change. A new UK customs system is currently in development to clear goods, and that means new types of forms to fill out and new systems for the classification of goods. As a consequence, the data required from organizations will change, and businesses will likely need nearly a year to confirm the compliance of their information technology systems, Bunch said.
“Brexit is mostly perceived as a tax problem for tax people,” says Jeroen Bijl, an Executive Director in EY’s Indirect Tax Team. “But when I talk to Chief Financial Officers, they realize what’s going to happen to their trucks at the border.”
Companies will need to consider how they would operate in and after the implementation period, particularly if the UK was to revert back to trading on World Trade Organization terms. This would include testing their supply chains for relevance and efficiency. In particular, they should consider what might be offered by the EU or the UK to address the cash flow impact of cross-border movements giving rise to value-added tax (VAT) upon import. It will be important to understand and agree with UK suppliers and buyers which party handles the border-crossing process, and to consider whether new UK licenses are needed to supplement existing licenses that span the EU.
Some of these changes will be merely logistical — altering stock-keeping unit (SKU) numbers to fit new classification systems, for example — whereas others will require lengthy negotiations with outsiders and the implementation of new IT systems.
“The challenge with Brexit is that the more you start thinking about it, the more issues you find that come up,” de Wit says.
At the very least, the agreement reached in December means the two sides can move on to the issues that matter for businesses, according to a statement released in December from Adam Marshall, Director General of the British Chambers of Commerce.
“It is imperative to keep up the momentum, as it’s high time to answer the huge practical questions on regulation, customs, standards, tariffs and taxes that lie at the heart of what businesses need to know in order to plan for the future,” Marshall said.
The common thread is to prepare to deal with an untested system. The current volume of customs entries processed through the UK is 55 million annually, and that’s expected to surge to 255 million as more traders will have to go through the customs process, according to HM Revenue & Customs.
A new customs system — already in development in the UK before Brexit — is scheduled to be implemented in the months leading up to March 2019. But it was designed to handle 60 million goods clearances annually — roughly a quarter of future expected demand.
“I’ve no doubt that in 10 years the UK can have a frictionless border for trade, but not within 2 years,” Bunch says.
Checks on truckloads originating from outside the EU at the Port of Dover currently take 45 minutes, according to a report from the Oxera economic consultancy. This figure could rise further if additional checks are required in the future. Subcontracting these tasks by hiring customs brokers won’t be an option for all EU organizations looking to move goods either, as that industry is also geared to handle roughly 55 million movements a year. The UK government, customs brokers and businesses will all be adjusting to the looming human resources challenge.
“German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit,’’ said Joachim Lang, Managing Director of the Federation of German Industries, speaking at a conference in Berlin in October 2017. “Anything else would be naive.” Lang cited the auto, logistics, energy, finance and insurance industries as the most heavily exposed to any Brexit changes.
Supply chains involving the Republic of Ireland could see the biggest changes. Goods for sale in Ireland are commonly routed through the UK right now. After Brexit, however, if customs checks were performed on all trucks passing through the Dublin Port between 5:30 a.m. and 7:30 a.m. each day, the lineup would stretch for nine kilometers, according to the report Brexit — the Voices of European Business. A plan by Dublin Port authorities to expand capacity won’t be ready in time for the change.
Despite the challenges and uncertainty, business will continue between the EU and UK and businesses on both sides of the new border need to plan now for the change. One option to supply the UK market would be to boost warehousing capacity in that jurisdiction and send fewer shipments, Bijl said. But waiting too long could mean paying a premium, as the UK is already short of retail warehouse space. Vacancy rates in mid-2017 had sunk to a historic low of 5.3%, thanks in part to the growth in online retailing in recent years, leading to those types of businesses occupying existing warehouse stock.
Another potential solution to cut down the time for customs clearance is to become an Authorized Economic Operator (AEO). This is a status attainable from the EU for any business involved in a cross-border supply chain, and allows for minimal checks to loads crossing in either direction. Both the UK and EU have said they will deal with the initial transition in the months following March 2019 by waving through shipments from organizations with AEO status, Bijl said.
Avoiding border disruptions means reforms beyond the supply chain as well. Contracts between UK and European businesses will now need to spell out which party is responsible for customs clearance. Typically, this would mean inserting clarifying language according to commercial terms defined by the International Chamber of Commerce, according to de Wit. It would likely make sense for the UK party to the sale to handle imports into that country rather than having European companies establish tax and VAT numbers. For some industries, the volume of contracts means they should get started now: “I’ve got some clients with 20,000 contracts,” Bunch said.
Those businesses operating in highly regulated sectors also face a laborious process to make certain that paperwork is in order post-Brexit. Pharmaceutical products, for example, may need a new set of licenses to be sold if they are coming from the UK into the EU.
“You need scientists who are held responsible for the quality of the drug working in the country in which a license is held,” Bunch says. “Getting a new license is a 15-month journey. It’s a bureaucratic process.”
Once a European business addresses these issues, attention can then turn to other beyond-tariffs concerns such as cash flow, Bijl says. As of March 2019, businesses moving goods between the EU and UK are likely to need to make VAT payments and file for refunds, which could come on a quarterly or monthly basis and leave companies with receivables to account for. Some countries allow deferred payments, including Belgium, Finland and the Netherlands, and businesses may find it worthwhile to route goods through these destinations instead of preserving existing trade routes, Bijl says. The UK may also introduce this facility post-Brexit.
“These are things you can do and think about now, even though we don’t know the result of Brexit,” Bijl says. “The main response of European companies so far is that they’re not going to do anything until they know the outcome of Brexit, but it’s going to be very important to be prepared.”
Key action points
- Preparing for Brexit means understanding what changes need to be initiated as soon as possible, such as updating IT systems to cope with new paperwork demands, or acquiring new licenses for products sold between the UK and EU.
- Supply chain reviews could help spot newer and more efficient routes to market, and eliminate ones that could become more costly or slower after Brexit.
- Cash flow factors to consider in the post-Brexit era include concerns such as VAT refunds.
Keeping your goods moving
All Brexit scenarios involve some form of UK-EU customs border implications, creating supply chain issues that may lead to additional costs and uncertainty. Whatever the outcome of current negotiations, businesses must prepare to navigate the changes ahead.
Six considerations for businesses affected by border changes:
- Moving goods in and out of the UK
- Impact on working capital
- Sourcing locations
- Validity of existing contracts
- Operating model suitability
- Immediate customs and border issues
Organizations should begin by reviewing their supply chains and taking pre-emptive actions. For example, applying for Authorized Economic Operator (AEO) status.
UK import and export capacity
- UK ports are expected to incur delays due to an estimated 360%+ increase (to circa 255m) in the number of import and export declarations post Brexit.
- Specific UK ports that have been EU-focused may be challenged in building the necessary customs clearance infrastructure. Newer ports (e.g., London Gateway) processing lower tonnage may have the potential to be more agile.
- EU ports must also be evaluated as they face significant increases in clearance demands.
- Additional inventory holding: increased lead times and the potential for disruption and increased volatility will result in more inventory.
- Import VAT permanent cash flow differential: contrasting with current cash flow neutral acquisition VAT, EU imports will require import VAT to be paid and then recovered.
Are your contracts still fit for purpose? Many EU-UK contracts did not envisage Brexit and are silent on such things as Incoterms. What terms do you want post-Brexit? How many contracts need to change and how long will it take?
Regional supply chain operating models
Many organizations run regional supply chain structures within the EU that have specific tax attributes. The impact of Brexit on centralized supply chain and procurement hubs hosted in the UK will depend on how they are configured. Basic physical supply chain questions need to be asked. Do I now need to consolidate? If so, where and which flows?
Suggested next steps
- Evaluate your supply chain: businesses need to understand the time sensitivity of their supply chain. Are there areas where delays will significantly impact the business?
- Perform data analytics and network optimization: businesses should look at where they can consolidate goods, how warehouses are sized, where they are located within Europe and whether relocation or revaluation of assets should be considered.
Becoming an AEO: AEO accreditation can enable businesses to benefit from faster customs clearances and gives assurance to HM Revenue & Customs that the business operates a secure and trustworthy import and/or export practice, allowing swifter approval of special procedures.
Businesses are already recognizing the benefit of AEO, as illustrated by the spike in applications in the chart below. Further promotion of the AEO regime, its benefits and assurances that will continue after Brexit, will ease transitional tension in trade.
Sources: Keeping your goods moving, EY, 2017
Details of the future trade relationship between the UK and European Union were unclear at the beginning of 2018. All information in this article was current as of January 16, 2018.
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