Out-Law News 5 min. read
24 Jun 2016, 10:32 am
This is part of Out-Law's series of news and insights from Pinsent Masons experts on the impact of the UK's EU referendum. Watch our video on the issues facing businesses and sign up to receive our 'What next?' checklist.
Leaving the EU will mean that the UK will no longer be obliged to maintain a system of VAT complying with EU requirements. The VAT system is set out in UK legislation, but is based on an EU Directive which requires member states to impose VAT at a minimum rate of 15%. UK courts and tribunals must apply VAT in accordance with the directive and EU case law.
Although the UK has a two year period from notifying that it is leaving to negotiate its exit from the EU, so nothing will change immediately, he said that businesses will be concerned about how Brexit will affect the VAT system in the future.
"Given the UK raises around £115 billion a year from VAT, it is unlikely to be abolished, but it is not clear whether it will continue to be based on EU law. Businesses will be hoping that the government opts to continue the system broadly along EU lines, as for businesses operating across Europe, it would be an administrative nightmare if the system diverged substantially from the EU one," Mellor-Clark said.
"It is unlikely that the government would reduce the overall rate of VAT below the EU minimum of 15% because of the significant contribution VAT makes to the Treasury. However, after leaving the EU, the UK would be free to impose different rates of VAT on different types of services and to widen the categories of goods and services benefiting from zero rating and exemption," he said.
In the referendum campaign, leave campaigners argued that Brexit would allow VAT to be scrapped on domestic heating and on sanitary products.
Under the current EU-based VAT system, financial services and insurance transactions with non EU counterparts allow VAT recovery on costs. The UK would have to decide how to deal with VAT recovery for EU transactions, according to Mellor-Clark.
"The City will eye VAT developments carefully. We would expect a relatively slow drift away from established principles of EU law. There will be winners and losers in this process. It's unlikely that core financial products such as mortgages, insurance and savings will become taxable. However, we could see the UK opt to claim victory in its long running battle to provide a wider VAT exemption for insurance intermediation activities" he said.
"In areas such as pensions and collective investment funds the news may be less rosy for taxpayers, as the UK has usually opted to impose VAT where the EU would have said it is not due," Mellor-Clark said.
Those already challenging the UK's VAT laws in the Court of Justice of the European Union (CJEU) also face uncertainty. The CJEU should continue to have jurisdiction whilst the UK negotiates its withdrawal but whether that will be the case after an exit, in relation to periods whilst the UK was within the EU, is not clear, he said.
Membership of the EU means that the UK is currently part of a customs union so that goods can be moved within the EU free of customs duties and import VAT. If the UK left the EU and did not join the European Economic Area or the European Free Trade Agreement, it would need to negotiate free trade agreements with the EU and with non-EU countries.
"Whether the UK is able to secure the same or improved terms to those currently available to it as an EU member would depend on the strength of its bargaining position. However, trade agreement negotiations tend to take an eternity, so a quick fix is unlikely," said Mellor-Clark.
Heather Self, a corporate tax expert at Pinsent Masons, said that the impact for direct taxes will not be so significant because, subject to not discriminating against EU nationals and complying with the fundamental freedoms in EU law, these are based on domestic rather than EU law.
"However, Brexit gives the Treasury the chance to introduce a law abolishing historic direct tax refund claims, based on EU principles such as freedom of establishment, which have proved very costly for the government " she said.
2015 figures from the Office of Budget Responsibility showed tax repayments by the government of £7.2 billion as likely and contingent liabilities to 2020 of £35.6 billion, although these do not all relate to EU claims.
"Groups which are currently relying on EU directives such as the parent subsidiary directive or the interest and royalties directive to reduce withholdings of foreign tax when profits from their subsidiaries are repatriated to the UK could see their overseas tax bill increase. Groups need to assess their exposure and in the long term, depending on the result of the Brexit negotiations, they may need to consider restructuring," said Heather Self.
The parent subsidiary directive allows dividends to be paid between EU member states free of withholding tax, if the parent holds which at least 10% of the capital of the subsidiary. Some double tax treaties also reduce the tax that can be withheld form dividends paid to companies owning more than a specified percentage of shares, but these do not always completely eliminate the withholding. The interest and royalties directive eliminates withholding tax on payments of royalties and interest between companies where one owns 25% or more of the capital of the other.
Once the UK leaves the EU it will no longer be subject to state aid rules, which prevent the giving of selective tax advantages to certain taxpayers or groups of taxpayers. Although the UK will still need to comply with World Trade Organisation (WTO) rules on state aid, the government may have more flexibility on providing state funding to business.
The European Commission has been investigating whether rulings by member countries on topics such as transfer pricing are in accordance with state aid rules. In October 2015 it decided that rulings provided to Fiat by Luxembourg ad Starbucks by the Netherland constituted unlawful State aid. As part of their investigations, all Member States have been asked to provide copies of previous rulings to the Commission for review.
“Although the UK is not currently being investigated for potential state aid breaches, it is clearly on the radar and some commentators have suggested that recent HMRC transfer pricing settlements should be referred to the EU Commission. Brexit could remove this potential avenue, although it would not do anything to allay the lack of trust which the Public Accounts Committee has expressed in HMRC,” Heather Self said.
"There is bad news for anyone hoping that leaving the EU will prevent the UK's implementation of the Organisation for Economic Cooperation and Development (OECD) base erosion and profit shifting (BEPS) recommendations to prevent tax avoidance by multinationals – in particular the restrictions on interest deductibility due to come into force in April 2017," she said. "As a member of the OECD, the UK is obliged to implement the recommendations and the increased tax receipts for the Treasury will be particularly welcome if we experience the economic turbulence forecasted by the 'remain' camp."