Brexit related international tax issues
Signed just one day before the end of the Brexit transition period, the Free Trade and Cooperation Agreement (TCA) was finally delivered on 30 December 2020 to govern the future relationship between the UK and EU.
With many uncertainties remaining until the very end of the transition period, businesses had little time to plan for the new rules before they came into effect.
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, five months after it came into effect, we can review the changes to other taxes for multinationals and evaluate the impact it has had.
Many countries withhold tax on the payment of interest, royalties and dividends paid from one country to another.
Under the EU rules, there is no requirement to withhold tax at source on payments of dividends, interest or royalties to companies in other EU Member States, provided relevant conditions are met.
Following the end of the transition period, this exemption ceased to apply to payments from EU companies to UK associates, which means withholding tax potentially applies.
For payments from UK companies to EU associates, the government brought these rules into its own domestic law, but it is due to repeal them from 1 June 2021. Once repealed, the requirement to withhold taxes on cross-border payments within the EU reverts to the UK’s domestic rules, subject to any reliefs in double taxation treaties, if indeed the UK has a treaty with that other country.
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 which should be reviewed 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 so, if tax is withheld by a paying country, double taxation relief may be available (subject to the treaty).
If a treaty does not provide for double taxation relief, the UK company may be able to obtain a deduction as an expense for the withholding tax suffered.
State aid and subsidies
While a member of the EU, the UK was subject to EU-wide state aid rules which prevented the government from providing aid to 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 such as Enterprise Management Incentives (EMI).
Having left the EU, those state-aid rules no longer apply to the UK, although they have been replaced by ‘Subsidy Control’ rules in the TCA. As a result, the UK is now free to set its own policies on subsidy control, although it has made a commitment in the TCA to maintain a ‘level playing field for open and fair competition’.
The UK government has already announced consultations on the possible reform of both the R&D and EMI schemes.
The Base Erosion and Profit Shifting (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 UK has already affirmed its commitment to continuing with the BEPS project, which was set up by the Organisation for Economic Co-operation and Development (OECD) to address the estimated USD$240 billion which 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, but, while still committed to BEPS, the UK is no longer subject to EU directives and can now implement its own policies.
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 it will no longer fully 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 either have the effect of circumventing the OECD’s Common Reporting Standard, or which 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, changing, for example, group loss relief rules and anti-avoidance.
While future CJEU cases may carry influence in the UK, the courts’ decisions will no longer be binding in UK law.
During the transition period, 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.
From 1 January 2021, the TCA includes a Protocol on Social Security Coordination. This 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. It should also 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 European Free Trade Agreement countries (Iceland, Norway, Liechtenstein and Switzerland) are not included in the protocol.
Secondly, the protocol does not provide for an extension for assignments beyond 24 months, whereas, under the EU Regulation, extensions of up to five years were possible.
Lastly, it is 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 not to 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, and in some cases, this will be significant.
The effect of the changes are far-reaching, with companies based outside of the UK and EU also affected. In some cases, this will make the UK considerably less attractive as a distribution hub for the EU.
Multinational 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.
Through our international business gateway, Kreston Duncan & Toplis, our team of dedicated advisers can help you with a wide range of international business services including advice and guidance on taxation. We can also unlock the support of our colleagues around the world through our membership of the Kreston international network of accountants, so you can benefit from local knowledge, wherever you do business.
If you would like advice, support, or guidance about trading internationally and your business, please, contact our team.