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International Tax and the Impact of Brexit
What is the impact of Brexit on international tax issues and the changes to taxes for multinationals?
Following the United Kingdom's exit from the European Union on 31 January 2020, the Free Trade and Cooperation Agreement (TCA) was finally delivered on 30 December 2020 to govern the future relationship between the UK and EU. This agreement was signed one day before the end of the transition period, after which the UK would have left the EU with no deal.
Many uncertainties in the nature of this agreement remained during the transition period which significantly reduced the time businesses had to plan for the new rules.
The most urgent considerations were in terms of import / export procedures, customs duties, and VAT, to ensure that cross-border trading activities could continue.
Now we are four months post Brexit, it is worth reviewing the changes to other taxes for multi-nationals.
Many countries withhold tax on the payment of interest and royalties and dividends paid from one country to another.
Under the EU Interest and Royalties Directive, EU companies benefited from an automatic exemption from withholding taxes on payments of dividends, interest and royalties.
The UK brought these rules into its own domestic law, but is due to repeal them from 1 June 2021.
From that date the requirement to withhold taxes on cross border payments within the EU reverts to the treatment agreed in double taxation treaties.
The individual tax treaty between the UK and the payer / recipient country must now be reviewed to confirm any requirement to withhold taxes.
While the immediate impact of Brexit was in relation to VAT and customs, there are many areas where direct taxes will be affected.
In certain cases withholding taxes may now arise due to the automatic exemption no longer being available, in these cases a review of the group structure and flow of funding should be carried out to ensure the business is not negatively impacted by these changes.
Specific areas to review on withholding taxes include withholding taxes imposed by EU countries on dividends to UK parent companies. There is generally no tax on dividends received by UK companies and therefore this can represent a real cost for groups.
For interest and royalties these will usually be taxable income in the UK and hence if tax is withheld by a paying country, double taxation relief may be available (subject to the treaty).
Where the treaty does not provide for double taxation relief, the UK company may be able to obtain a deduction for the withholding tax suffered as an expense.
State Aid and Subsidies
The UK, while a member of the EU, was subject to EU wide state aid rules which prevented state aid being provided to UK companies in certain circumstances.
From a corporate income tax point of view this impacted numerous UK government tax incentives including Research and Development (R&D) Tax Credits and tax favourable share option schemes e.g. Enterprise Management Incentives (EMI).
Given the EU state aid rules no longer apply to the UK, these rules have been replaced by 'Subsidy Control' rules in the TCA.
The result being that the UK is now free to set its own policies on subsidy control, albeit there is a declared commitment in the TCA to a 'level playing field for open and fair competition'.
The UK government have already announced consultations on the possible reform of both the R&D and EMI schemes.
The UK has already affirmed their commitment to continuing with the Base Erosion and Profit Shifting (BEPS) project driven by the Organisation for Economic Co-operation and Development (OECD).
The BEPS project is a collaboration of over 135 countries aiming to put an end to tax avoidance strategies which exploit gaps and mismatches to avoid paying tax.
The OECD estimates that USD$240 billion is lost annually due to tax avoidance by multinational companies.
Internationally focussed tax avoidance legislation will therefore remain a pillar of the UK tax system.
While still committed to BEPS, the UK can now implement its own policies and is no longer required to follow EU directives.
An example where the UK is already diverging from agreed EU rules is DAC6, which is an EU directive requiring taxpayers and intermediaries (e.g. lawyers, accountants and tax advisers) involved in tax 'arrangements' to disclose these to their local tax authorities.
The UK government announced they will no longer participate in this regime, instead choosing to implement a lighter reporting regime based on the OECD's Mandatory Disclosure Rules set out in BEPS Action 12. This means that only cross-border arrangements falling under the Category D Hallmark (broadly, those that (a) have the effect of circumventing the OECD’s Common Reporting Standard or (b) obscure beneficial ownership) will be reportable.
Role of the European Court of Justice (CJEU)
The UK will no longer be bound by decisions reached at the CJEU level. Previously these decisions resulted in many amendments to UK tax legislation for example, group loss relief rules and anti-avoidance.
Therefore, while future CJEU cases may carry influence in the UK, the courts' decisions will no longer be binding in UK law.
The Withdrawal Agreement regulated social security between the EU and the UK from 1 February 2020 until 31 December 2020. This made it possible for persons in a cross-border situation to continue benefiting from the more generous social security coverage under the EU Regulation for coordination of social security systems in the EU (the European Regulation).
From 1 January 2021, the TCA includes a Protocol on Social Security Coordination (the Protocol).
The Protocol ensures that individuals who move between the UK and the EU after 1 January 2021 will continue to have access to reciprocal healthcare cover and that cross-border workers and their employers are only liable to pay social security contributions in one state at a time. Generally, this will be in the country where work is performed.
According to the Protocol, it should be possible to obtain a certificate confirming the country of insurance for multi-state workers and detached workers (if applicable).
Employers must register with the appropriate foreign authorities to remit employee and employer contributions on a monthly basis according to domestic legislation.
The coordination rules from the Protocol are generally the same as the rules as laid down in the European Regulation on social security.
However, there are some important differences:
First, the EEA-countries (Iceland, Norway and Liechtenstein) and Switzerland do not fall under the Protocol.
Secondly, the Protocol does not provide for an extension for assignments beyond 24 months. Under EU Regulations extensions of up to five years were possible.
Lastly, it important to note that the Protocol does not apply the same scope of social security as the EU Regulation. The Netherlands have, for example, decided to not include all parts of the Dutch social security scheme under the Protocol; the Long Term Care Act and family benefits, such as child benefits are excluded.
It is clear from the Protocol that social security between the EU and the UK has changed significantly and advice should be taken to understand the full implications of these changes.
While the immediate impact of Brexit was in relation to VAT and Customs, there are many areas where direct taxes will be affected, in some cases significantly.
The effect of the changes are not limited to companies operating in the UK or EU and can impact the rest of the world, in some cases making the UK considerably less attractive as a distribution hub for the EU.
Multi-national companies trading with the UK or EU should review their direct taxes as soon as possible to identify any areas where Brexit has created problems or unexpected tax consequences.
Written by Mark Taylor International Tax Leader, Kreston International