EU: Possible tax consequences of UK referendum

EU: Possible tax consequences of UK referendum

UK voters decided on 23 June 2016 in favor of leaving the EU. Given that this “Brexit” will necessarily have major consequences for both the UK and the EU, it is expected that defining the terms and conditions of such a withdrawal will take at least two years and involve challenging negotiations on both sides. Following this result, British Prime Minister David Cameron announced his intention to resign within the coming months.

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Tax consequences

The outcome of the UK referendum will affect the UK tax system, given that European law affects UK tax law (both as regards direct and indirect taxation):

  • UK direct taxation is subject to a number of EU directives, EU principles stemming from the Treaty on the Functioning of the European Union (TFEU) and the jurisdiction of the Court of Justice of the European Union (CJEU). In particular, UK domestic law cannot conflict with principles of EU law, such as the “four fundamental freedoms” and EU State aid provisions. 
  • Value added tax (VAT), as well as customs and excise duties, are all governed directly by EU law, which means that both the EU law and the CJEU case law are the main sources of UK indirect tax legislation. 
  • Membership of the EU gives UK companies access to the internal market (made up of 28 EU Member States) and to a broad network of preferential trade agreements between the EU and third countries.

Currently, it is difficult to assess in detail how the Brexit will affect UK tax legislation in a near future, as this will mainly depend on the terms of any post-Brexit agreement to be concluded with the EU.

Norwegian scenario

One possible scenario is that the UK becomes a member of the European Free Trade Association (EFTA) and retains access to the European Economic Area (EEA) and the customs agreements that EFTA has with the EU, similar to the current status of Norway. However, the UK will no longer be part of the EU VAT area, and will have to negotiate a bilateral trade agreement with the EU. Under such a scenario, the EU principles enshrined in the TFUE, such as the fundamental freedoms and the State Aid regulations, would remain applicable to the UK. However, the UK would no longer benefit from the withholding and corporate income tax relief offered by the EU Directives (such as the Parent-Subsidiary Directive, the Interest and Royalties Directive, or the Merger Directive). For the UK, membership of the EEA would still be synonymous with strong integration with the internal market.

Swiss scenario

Another scenario is that the UK remains a member of the EFTA, but does not join the EEA and negotiates a separate bilateral agreement with the EU, similar to the current status for Switzerland. If the UK chooses not to become part of any customs free trade area or trade association, the country would no longer be subject to EU legislation. In the context of portfolio investments in the EU, the UK will nevertheless—as any other non-EU country—still be able to benefit from the free movement of capital. At present it seems unlikely that any major changes will be introduced in the UK tax system as a result of the referendum. EU Directives that have already been implemented in UK law as well as existing income tax treaties will most likely stay in place and could limit potential negative consequences for companies resident or active in the UK. While the UK will lose the benefit of the protection against discriminatory tax measures being imposed by other EU Member States, it will also regain the possibility of introducing tax incentives, for example, irrespective of the limits imposed by EU principles. Nevertheless, the extent to which the UK will face political pressure from the EU in this respect is still unknown.  

 

Read a June 2016 report [PDF 359 KB] prepared by KPMG’s EU Tax Centre

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