Brexit Monitor A European view

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1 Economics and tax post-brexit In contrast to the situation in the UK, the first readings from European indicators of business and consumer confidence suggest that economic activity has only been modestly affected by the UK s vote to leave the EU. In this week s Monitor we look at the first hard data which gives an indication of the impact on the European economy. In addition we also provide a deep dive into tax, one of the areas where change will be both most complex and most apparent. Brexit Monitor A European view 4 Despite falls in some financial market indicators, the overall message is that neither business nor consumer confidence in Europe seem to have been hugely affected by the UK referendum result. While it seems that Brexit has ended the chances of a strong revival of growth in the second half of 2016, it will likely not push the European economy towards a more marked slowdown. Figures suggest, in line with our PwC forecast, that growth will slow only modestly in 2016 and Furthermore, the European Central Bank (ECB) decided at its July meeting not to provide new policy support measures but has said that it would calibrate its response to Brexit at its next meeting in September in light of the next set of ECB staff projections. The Eurozone composite purchasing manager s index (PMI) came in at 52.9 in July of 2016, down from 53.1 in the previous two months. It is the lowest reading in 18 months, but represents a much more modest fall than the indicator published by the Centre for European Economic Research (ZEW) and which we reported on last week. Slower growth in both manufacturing and services explain this week s PMI reading. Likewise the sharp drop in sentiment reported by the ZEW, was not carried over to the European Commission s 1 flash estimate of consumer confidence in the euro area which barely dipped in July, down by 0.7 to For the whole EU, including the UK, as well as some emerging economies in the CEE which have been hit harder by the UK vote than their Western peers, the consumer indicator decreased by a marked 1.8 points to The Commission s economic sentiment indicator (ESI) remained resilient in the Eurozone, marking a marginal increase of 0.2 points to 104.6, and decreased in the EU by 0.9 points to Data released last week also suggest that Europe s largest economy is holding up better than expected. The Germany composite PMI came in at 55.3 in July of 2016, up from 54.4 in June. This marks the highest reading so far this year as growth in the services sector accelerated. The German services sector PMI increased to 54.6 in July, up from 53.7 in June, while the manufacturing PMI eased slightly at 53.7, down from 54.5 in June. Similarly, sentiment in the German economy according to the German IFO institute s survey, weakened only slightly in the wake of the UK referendum. The IFO business climate index fell from points in June to points in July due to slightly less optimistic business expectations on the part of companies. However, assessments of the current business situation had improved slightly. In manufacturing the forward-looking business climate index fell, although manufacturers were satisfied with their current business situation. The automotive sector, on the other hand, reported pessimistic business expectations. 1 DG ECFIN, 20 July PwC Brexit Monitor - Issue 4, July

2 Consumer confidence in the Euro Area Balances % EA long-term average Source: European Commission services The EU Commission s first assessment post-brexit In a recent first assessment of the economic situation post-brexit, the European Commission confirms that the UK s referendum vote could damage the economic recovery otherwise underway in the EU. While in recent months economic expansion in the EU has been sustained at a moderate pace, the UK s leave vote is expected to slow private consumption and investment and, have impact on foreign trade. In its first assessment the Commission modelled two scenarios: one mild and one severe uncertainty shock. The expectation is of a loss to GDP of % by 2017, for the remaining 27 member states minus the UK. At the current juncture, the Commission s economic outlook is mainly affected by the uncertainty resulting from the vote and from what is expected to Euro Area (EA) European Union (EU) be a protracted period of exit negotiations. Without information about the relationship between the UK and the EU after the UK s exit, a new equilibrium is difficult to pencil in. This implies that the uncertainty shock could evolve quite differently in terms of dimension and duration. While uncertainty is expected to diminish over time, forthcoming changes in the economic and political relationships between the UK and the EU could have a longer lasting impact on the medium- to long-term economic outlook. Due to the lack of information about the scenario after the UK s exit, many elements have not yet entered the assessment but nevertheless constitute substantial risks to the Commission s outlook. Those come on top of the previously identified risks. In summary, the UK s vote to leave the EU has generally increased downside risks to the economic outlook. The European political context Politically the main news this week has been the Commission s appointment of former EU Commissioner and French Secretary of State for European Affairs, Michel Barnier. The choice of a Frenchman who is known to be both a tough negotiator and to take a hard line on EU rules is an important aspect of the upcoming EU-UK negotiations, but need not have the significance that headlines in the UK media suggest. During his time as Commissioner for the Internal Market and Services from , Michel Barnier oversaw much of the uneasy and sometimes tense dialogue between the Eurozone and the UK, and while taking a tough stance on banking regulation, he also stroke compromises with the UK not always to his own government s liking. Likewise as Secretary of State in the 1990s, Barnier already worked with David Davis, the UK s Brexit negotiator. While often politically at opposite sides, the familiarity between persons could lend some more predictability to the negotiating procedures. As a backdrop to all this, it is also important to keep in mind the institutional struggles in Brussels. While the Commission is the EU s lawmaker, political decisions are made at the Council level. This suggests that the key negotiations will take place under Council President Donald Tusk and the leaders of the other EU member states. As such, the role of the Barnier-Davis duo may be to lay out the options, but to leaver the choices for others to decide. In an indication of the importance of individual EU member states, the UK Prime Minister Theresa May has visited Poland and Slovakia this week, where the free movement of people is likely to PwC Brexit Monitor - Issue 4, July

3 be a main agenda point, following visits to Germany, France and Italy last week. Moreover, the past week has provided clarity over the timetable for the UK to start its exit process. The UK Prime Minister s meetings last week with French President Francois Hollande and German Chancellor Angela Merkel, clarified that there is an understanding of the UK s need to refine its negotiating position over the next coming months. In line with previous expectations, this continues to suggest that the article 50 negotiations will be triggered early next year, with the UK actually leaving the EU in early The timetable seems to satisfy all participants as elections in France and Germany in 2017 will be the focus in the EU s two biggest member states in the year ahead, while the UK government would be keen to finalise Brexit before its own next general elections in Likewise, the European Parliament would be eager to conclude the matter ahead of European elections in In terms of the main sticking point for the UK migration, European Commission President Jean-Claude Junker reiterated last week that in order to retain full access to the single market, the UK would need to accept the free movement of people. This view was shared by both Francois Hollande and Luxembourg Finance Minister Pierre Gramegna. The German Chancellor took a more nuanced stance, indicating that the right answer to this question, may only be given once the UK has finalised its internal negotiating position and put forward a concrete request. However, net migration levels in the UK may well decline as a natural result of the deteriorating economic conditions, and in particular labour market conditions. A report by the UK based Social Market Foundations estimates that migration could come down to 99,000 by 2020, compared to the record number of 330,000 registered in This might ease the UK government s stance on the free movement of people via-á-vis the EU, as the new cabinet also seems keen on avoiding a commitment to hard numbers on migration (in contrast to former PM David Cameron s repeated pledge to bring down net migrations to tens of thousands). However, as noted in the previous weeks Monitors, the main feeling in the EU is that Europe has already moved on. The UK referendum aside, the more immediate challenge for European policy markers is October s constitutional referendum in Italy, where the government currently faces the same sense of populist dissatisfaction that led to the UK s leave vote. It is therefore no surprise that there is a sense of urgency in trying to resolve the problems facing Italian banks. The surprise is instead perhaps ECB President Mario Draghi s decision to weigh in on the debate, presenting the ECB s solution to the Italian banking problem. The UK s EEA interim solution While it looks increasingly likely that the UK will aim for a bilateral trade deal along the lines of Canada s, one compromise which is increasingly being discussed, is for the UK to enter the EEA for a transitional period in order to navigate through the period of uncertainty. This would give the UK time to agree a tailored agreement with the EU, and giving business time to adjust to a future outside the single market. Formally the UK cannot agree new trade agreements with non-eu states until it has left the EU, providing another reason why a transitional EEA membership could look attractive. The difficulty for the UK would be to sell the free movement of people, which still comes with EEA membership, to the leave voters. However, a transitional EEA arrangement could be one way to win Scotland s agreement to stay in the UK and/ or to ease the burden of simultaneously seeking to renegotiate both its trade relationship with the EU and all of the UK s other trade partners. Some rumours have also circulated that the UK could avoid an article 50 process by unilaterally repealing the 1972 European Communities Act. This suggestion should be treated with a high degree of scepticism as any UK government seeking to negotiate a new favourable deal with its EU partners would want to avoid damaging an important relationship in the run-up to negotiations. If anything the UK government will likely want to behave at its best in order to create as much goodwill as possible in the coming months. PwC Brexit Monitor - Issue 4, July

4 The tax implications of Brexit Tax As a direct consequence of the UK s vote to leave the EU, businesses operating in the UK and in the rest of the EU face uncertainty in many areas. One of these areas is the impact on the tax and legal system in the UK post-brexit, as well as tax and legal implications in other EU member states once the UK leaves the EU. Below is an overview of the most important tax implications for international trade, people and corporation taxes that may affect a wide variety of business activities. Please note that the terms and conditions of the UK s withdrawal from the EU will be subject to extensive and unprecedented negotiations that will take at least 2 years, and potentially longer. Therefore, the full extent of the changes will not be known (or effective) for quite some time. In addition, the impact of Brexit on the tax and legal system in the UK will strongly depend on which of the scenarios that PwC has identified will materialise and how the UK will deal with proactively withdrawing EU based legislation in cases where there is no obligation to do this. Situation Potential implications Tax impacts EEA member (Norwegian option) The UK becomes an EEA member and keeps the four freedoms of people, capital, goods and services The UK would need to contribute to the EU budget and comply with EU social, employment and product regulation This scenario would allow the UK to retain access to the single market, but even if this achieved the red tape will increase significantly while the UK would not have full freedom in setting customs rates. It is unlikely that the intra-community VAT system will remain in place in its current form. Furthermore, the status as an EEA country comes with most benefits (and restrictions) very much in line with the current EU membership for the (tax) treatment of individuals. Corporate tax legislation may be affected but the consequences may be relatively remote. Free Trade Agreement (FTA) The UK negotiates a Free Trade Agreement (FTA) with the EU Potentially tariff-free trade between the UK and the EU Depending on what agreement is reached, the customs between the UK and EU may be comparable to the EEA alternative. Movement of people will likely be restricted but this would need to be arranged separately, in addition to the trade agreement. VAT and corporate taxation will no longer need to be aligned and we expect significant differences in legislation in the medium- to longterm. Bilateral Agreement (Swiss option) The UK negotiates a bilateral integration treaty with the EU The UK would have access to some areas of the Single Market, at the cost of adopting the relevant EU regulations In a bilateral agreement similar to that of Switzerland, it is likely that the customs regulations become similar to the EEA alternative. Free movement of people depends strongly on the details of the agreement (Switzerland for example has free movement of people but is seeking to limit this following a referendum in 2014). The UK would have independent VAT legislation. Certain elements of corporate taxation may still remain applicable depending on the exact agreement reached. No access agreement (WTO/ MFN) The UK does not establish any new trade agreements with the EU Only WTO terms apply UK goods and services would be treated in the same ways as those of third countries This scenario would mean a complete separation of the UK from the EU from a tax regulation perspective. Amongst other things this would mean no access to the single market and the UK would be free to set its own customs rates. The movement of people would be restricted although separate agreements may be concluded to arrange for some form of movement of people, but it remains uncertain if the EU member states will be open to conclude a separate agreement to (continue to) apply the free movement of people. Corporate tax and VAT regulations will no longer need to be aligned between the EU and UK. These scenarios are the most likely, however a number of variations could be negotiated PwC Brexit Monitor - Issue 4, July

5 International trade Tax The EU member states together form a customs union, meaning that the EU is treated as a single territory for customs purposes and that, in principle, the same rules and rates apply in each member state. Once goods are in free circulation (i.e. all duties paid and import formalities completed) in one member state they can move freely to other member states, without further payment of customs duties or further customs formalities. Furthermore, the EU member states share common external tariffs vis-à-vis third countries. If the UK becomes a third country following its exit from the EU, customs duties may be due again in the event of an import to and/ or from the UK. Whether, and to what extent, the EU and/or the UK will levy customs duties on goods coming from the UK or the EU respectively, will become clearer once the shape of the new relationship between the EU and UK is known. It is clear however that the outcome under the different scenarios can differ significantly (between low impact if the UK becomes an EEA member or potential high impact under a WTO scenario). When the UK leaves the EU, the default position is that it will qualify as a so-called third country. Regardless of which model or (free) trade agreement will materialise, and regardless of whether or not customs duties will become due, goods shipped across the EU-UK border, will be deemed to be exported to and imported from the UK. Consequently those goods must be declared and cleared through customs, and customs declarations must be filed. This process will be subject to costs and possibly time delays. This will also be the case for VAT purposes; instead of an intra-community supply or an intra-community acquisition, goods will once again be deemed to be imported/exported and VAT will be due upon import into the respective EU member state (with application of the reverse charge system) and into the UK. This, as well as additional documentation requirements for VAT-exempt third country exports, will result in administrative procedures and additional costs. Another area that may be affected is the EU customs legislation system of authorisations that also apply in cross-border situations (for example, one authorisation for the storage of goods in a customs warehouse with storage in different member states). Where such authorisation was granted and is managed in the UK, it may be necessary to re-allocate such authorisation to one of the other member states. In line with this, a practical implication may also be that the EU system on the tariff classification (BTI) and/or the (preferential) origin of goods (BOI) no longer applies and hence any binding information rulings and decisions issued by the UK may no longer be valid once the UK has left the EU. Finally we note that although excise duties are a national levy, in principle charged by the country in which the goods are consumed, a uniform system applies within the EU under which excise goods may move between member states (Tax Warehouse & EMCS) under duty suspension. Once the UK leaves the EU, the UK may be excluded from this system and excise goods may be deemed to be exported from the UK and imported into the respective EU member state and vice versa. Again a consequence of this may be that additional formalities, and possibly the provision of additional guarantees, may be required. In our view it is unlikely that the EU would grand the UK access to the single market without the UK fully accepting the free movement of people, something which the UK will unlikely accept. Hence, we expect that the movement of goods between the UK and the EU will become subject to more complexity and higher transaction costs. PwC Brexit Monitor - Issue 4, July

6 VAT Tax Regardless of the industry, if companies have cross border operations involving the UK, VAT changes will arise in any post-brexit scenario. One of the few certainties of the Brexit process is that the UK will have its own VAT system. This may of course look very similar to the current system. Businesses should make a timely assessment of the impact on their operations. The common internal market with free movement of goods and services is one of the key achievements of the EU. One of the main consequences of the UK leaving the EU from a VAT perspective, will be the end of the free movement of goods and services. This means that the intra-community trade system will no longer apply for goods and services supplied to UK companies by EU companies and vice versa. The UK will be regarded as a third country from a VAT perspective. All supply chains to, from and via the UK will be affected by changing VAT treatments and reporting obligations even when goods do not physically move through the UK, but are supplied to or by a UK entity or under a UK VAT number. Moreover, adverse cash flow implications may arise e.g. in relation to import VAT and foreign VAT incurred. Examples of consequences can be found in VAT reporting requirements (no EU Transactions Listings or Intrastat declarations would be applicable in the UK), but also in the way transactional mappings are set up in ERP systems (change from intra-eu system to an export/ import system) and the use of certain beneficial EU provisions (simplified triangulation would no longer apply). ERP system impact Once the UK leaves the EU, it would no longer have the obligation to adopt the EU VAT Directive. This could result in changes in VAT treatments, VAT rates (decrease/increase but also high rate and low rate material qualifications), exemptions and in the compliance process. These VAT changes will need to be translated into ERP adjustments when implemented. Additionally, if companies use, for example, simplified triangulation or if the distance selling threshold disappear, this would trigger VAT changes. When VAT changes occur, the ERP system would need to be adjusted accordingly. Industry lens The main industry impacts we currently foresee from a VAT perspective are in the field of financial services, arts and pharmaceuticals & life sciences. One of the specific areas that might be amended and could have a significant impact for the financial services industry, is the scope and application of VAT exemptions on insurance and financial services. To counter this, the UK government may wish to broaden the application of these VAT exemptions. This might for example be the case for VAT exemptions for outsourcing in the FS sector. The pharmaceutical industry is a vital part of the UK and European economies. Currently, Britain is a significant hub for life science companies. One of the very important features of the single European market for pharmaceuticals is the European Medicines Agency s (EMA) EU centralised licensing system for market access of new pharmaceutical products (the one-stop-shop for EU drug approvals). For reasons related to, inter alia, VAT and customs duties, the UK has been trying to attract foreign pharmaceutical, biotech and med-tech companies carrying out clinical trials in the EU. One of the main selling points has been a flexible application of the EU s Customs exemption for Goods imported for examination, analysis or test purposes which resulted in relative simple procedures and therefore a reduced VAT and customs compliance burden. After a UK exit from the EU this will no longer be possible. The UK has by far the largest world market share of all the European countries in the sales of art and antiques via auctions. For the system of UK VAT when the UK leaves the EU, one consequence might be that the UK will abolish the current VAT levy on the margin of the UK auctioneer for international auctions. If so, the position of the UK-based auction houses could become more competitive in relation to EU auction houses. PwC Brexit Monitor - Issue 4, July

7 People Tax The consequences of the UK leaving the EU on the UK nationals living and working in the rest of the EU, as well as EU citizens living and working in the UK have been widely debated in the media. How and when will they be affected? Should companies amend their global mobility policies already now? What will happen to social security? How should companies communicate with employees in those uncertain times? We will zoom in on some of the key areas below. Immigration requirements The exit of the UK from the EU could mean the end of the EU s current free movement of people in the UK. This would impact EU nationals seeking to work, study, or simply move to the UK, and also UK nationals wanting to move to or continue to live/ work within the EU. It may also impact businesses ability to recruit and deploy high and low skilled individuals from the UK to the EU or vice versa. is coordinated by EU directives. The social security legislation of the home/posting country may exclusively (and mandatorily) apply under the relevant EU regulation. Once the UK is no longer in the EU, this may no longer be an option. As a consequence, risks of double coverage exist in cases where work is performed in several countries at the same time ( multi-state ), and in cases of posted workers. In addition, employers will need to ensure they have a clear understanding of the current social security position of their globally mobile employees from or in the UK and be able to ascertain how these may change, both in order to advise their employees but also to understand the potential cost implications for their business. For example, the UK has only concluded social security conventions with a few other countries through which the risk of double (or non-) coverage is mitigated. pension rights/assets (e.g. increased administrative burden relating to transfers of assets or pension entitlements). Furthermore, certain (exit) levies may apply to the accrued pension entitlements if an individual moves from an EU member state, in which the pension funds have been accrued, to the UK. Regulatory impact for employees remuneration for financial institutions The key question is the extent to which remuneration regulation for financial institutions will change (and, if so, in what way). A number of the remuneration regulations currently in force in the UK are derived from (or have been significantly based on) EU legislation. As a result, one of the key questions arising from the outcomes of the EU referendum will be the extent to which these remuneration regulations will remain in place in the UK, or change once the UK s exit from the EU becomes effective. A new agreement between the UK and the EU, may still give partial access to the EU market and allow some free movement of persons. However, we recommend employers to assess the potential implications for their workforces, the impact for hiring new employees, and make sure they are ready for a new immigration landscape of border controls and visa requirements, in the event that such a scenario would become a reality. Social security coverage At this moment, the applicable social security legislation in cases of cross border employment, Pension accrual/pension payments Pension and pension accrual within the EU is regulated by several EU Directives. EU member states have implemented the Directives into their national legislation. Depending on the exit scenario the legislation implemented in the UK as a result of these Directives may be cancelled. As an example currently EU nationals benefit from continued pension accrual under a foreign scheme during an assignment period within the EU/ EEA. This may not be possible once the UK is no longer part of the EU. Problems may arise during the pension payment phase in respect of the transfer of accrued Furthermore, if financial institutions decide to move office location from the UK to another EU member state, the question arises what the impact may be on the tax position of the individuals involved, as well as if, and to what extent, remuneration regulations in the new location will limit agreed or new performance based remuneration plans and policies. Several EU member states have indicated that they would welcome institutions if they decide to relocate to the EU and have suggested they would relax current restrictions, and/or introduce expatriate facilities to facilitate such relocations. PwC Brexit Monitor - Issue 4, July

8 Corporate income tax Tax Compensation and employee engagement Changes within executive compensation are likely to be driven by factors such as public perception and alignment to company strategy in the short/ medium term rather than the UKs vote to leave the EU. However, we do expect that the vote to leave and the current uncertainty in the markets may lead to a change in business strategy and consequently employers may consider reviewing their current remuneration plans and policies, including revisiting existing targets where Brexitrelated uncertainty has impacted the business negatively. Employers may also need to engage with their employees, and key talent in particular, as fear of change and uncertainty may reduce workforce confidence and productivity. Employers will need to equip themselves to understand specific employee concerns, from job security to impact on compensation strategies, in order to motivate and retain talent. Hence good and frequent communication on the impact of the UK s vote to leave the EU on the strategy of the organisation is key. Finally, depending on whether any extension of existing rules post-brexit can be negotiated between the UK and the EU, UK nationals working in the EU may no longer be entitled to certain benefits or allowances for which only EU nationals are eligible. Direct taxes such as corporation tax are not within the direct competence of the EU but are the prerogative of each of the member state even though member states have agreed to regulate certain direct tax matters through Directives. These Directives have also been implemented into the UK tax system. The UK s exit from the EU has no direct impact on those provisions in UK tax legislation. Instead the UK may choose to keep, adapt or remove them. In addition to potential UK tax law changes, business should be aware that there are a significant number of provisions in the local tax legislation of the other EU member states which directly refer to the EU/ EEA often as a condition to grant a beneficial tax treatment. As a potential consequence of the UK leaving the EU, other member states will no longer be bound to apply those beneficial tax rules in relation to transactions with the UK, so various protections would potentially be lost (although through interim EEA membership, tax treaties or other arrangements the effects may be reduced). Below we look at some specific examples. EU Parent-Subsidiary Directive Under the EU Parent-Subsidiary Directive, no dividend withholding tax may be levied on the distribution of dividends from an EU company to its parent company which is tax resident in another EU member state, provided certain conditions are met. At the same time, the country of the EU parent company has to eliminate any additional/ double taxation on the profits distributed as dividends to it by its subsidiary resident in another EU member state. When the EU Parent-Subsidiary Directive no longer applies to the UK, the situation will revert to a bilateral tax treaty with the UK, allowing for a reduction in dividend withholding tax. EU member states have different tax treaties with different withholding tax rates and different conditions apply. Will this be levelled out through the exit negotiations or a new agreement? If not, business should assess how to optimise their corporate structure to avoid tax leakage. EU Interest and Royalty Directive A similar arrangement exists for interest and royalties under the EU Interest and Royalty Directive. On the basis of this Directive, no withholding tax may be levied on the payment of interest or royalties to or from a company in the UK, provided certain conditions are met. When the EU Interest and Royalty Directive no longer applies to the UK, the system will revert to a bilateral tax treaty with the UK, allowing for a reduction in withholding taxes on interest or royalties. In addition to interest and royalty payments between parent and subsidiary, the EU Interest and Royalty Directive also in principle disallowed the collection of withholding taxes on payments between EUsister companies with a common parent in another EU member state. For all these scenarios, the question arises again how the UK and EU will deal with this in the exit negotiations and in the new agreement with the EU. There is a need for business to reconsider the financial flows within the group to minimise adverse tax consequences. PwC Brexit Monitor - Issue 4, July

9 Tax EU Merger Directive Under the EU Merger Directive, profits realised on cross-border mergers between companies domiciled in the UK and other member states may under some circumstances be exempt from corporate income tax. When the EU Merger Directive no longer applies to the UK, cross border reorganisations involving a merger with the UK may become tax inefficient. In some EU member states, tax deferred reorganizations rules also extend to EEA member states. Hence, if the UK should choose to become and EEA member, the impact of the EU Merger Directive no longer being applicable for crossborder reorganizations involving UK taxpayers may be mitigated, depending on the circumstances of the specific case. European case law: cross-border loss relief and group taxation In the last decades the European Court of Justice (ECJ) issued various rulings which are of high relevance for the application of domestic tax provisions of the member states. When the UK ceases to be a member state, this case law may partially or wholly lose its relevance for the UK. For example, following various ECJ rulings, a member state must, under certain conditions, allow a business of that member state to set-off losses incurred in another member state (cf. ECJ Marks & Spencer, ECJ Lidl Belgium, or ECJ Deutsche Shell). The same would apply for the ECJ case law which allows indirect tax groups with intermediate EU entities. Also these types of tax groupings, and hence the potential to offset profits and losses, may no longer be available post-brexit. Another example of an ECJ ruling that could impact business negatively can be found in the ECJ Saint Gobain ruling. As a consequence of this ruling, a branch in a member state of a head office in another member state, has access to bilateral tax treaties between the member state of the branch and third countries. This may be relevant for withholding tax reductions and for the application of the rules for the elimination of double taxation. When the UK ceases to be a member state, for example a branch of a German company in the UK (or vice versa) will in principle no longer have automatic access to bilateral tax treaties between the country of the EU branch and third countries. European case law: further indirect tax implications based on legal recognition of foreign entities Certain ECJ rulings on corporate law issues have also had indirect but significant implications for the tax treatment of entities formed in one EU member state but managed in another EU member state, or in case of an EU entity migrating within the EU. In particular, the ECJ established a rule pursuant to which a host EU member state has to recognize the legal personality of a company established in another PwC Brexit Monitor - Issue 4, July

10 Tax member state which shifts its residence to the host state, if the home state continues to respect the legal personality despite the migration (cf. ECJ Centros, ECJ Überseering and ECJ Inspire Art). For example, Germany, which used to refer to the effective place of management for determining the legal status of an entity rather than to the place of its incorporation under its domestic law, had to recognize the legal personality of a UK Ltd company (relying on the place of incorporation for legal status) even if the UK-incorporated company is managed in Germany. From a tax perspective this also means that the company had to be respected as a corporation for German tax purposes. Once the UK leaves the EU, this may no longer apply, and may even result in deemed liquidation taxation since the company may, depending on the circumstances be treated like a partnership or branch. It is strongly recommended to analyse such effects before the change becomes effective and while a tax deferred reorganization within the EU is still possible, if the requirements are met. EU relevant provisions in bilateral tax treaties Another area of potential impact for business is included in the fact that a number of bilateral tax treaties contain provisions that require a person to be domiciled in an EU member state in order for the tax treaty to be applicable. An example is the Limitation on Benefits ( LOB ) clause in the 1992 tax treaties between the US and EU countries like the Netherlands or Germany. When the UK ceases to be a member state, such provision will no longer be applicable to a Dutch person domiciled in the UK. Similarly, if the UK would no longer be an EU or EEA member state, a German company which is UK owned may no longer rely on equivalent benefits being granted between the US and the UK under the US-German Double Tax Treaty, where it receives a payment from the US but does not fully qualify itself under all requirements of the LoBclause. The analysis may change again, though, if the UK would join the North American Free Trade Agreement (NAFTA) after leaving EU/EEA. International structures and bilateral tax treaties Following the exit of the UK from the EU, the relationship between the UK and other member states will, in principle, be governed by bilateral tax treaties between the UK and the individual member states. The Netherlands has a relatively new and favourable tax treaty with the UK on the basis of which withholding tax on dividends paid from the Netherlands to the UK may be as low as 0%, and withholding taxes on interest and royalties paid from the UK to the Netherlands are also 0%. Therefore, it may be attractive for holding companies domiciled in the UK to operate via a Dutch holding company holding their EU subsidiaries, in order to benefit from the EU Directives via the Netherlands. Tax implications of Brexit-induced impacts on values and business plans Depending on the specific industry sector and a company s operating model, Brexit may result in cost increases for the movement of goods between the UK and the EU and vice versa, as well as an increase in costs of employment. This may also result in write-offs of goodwill for UK operations or for operations in EU member states with a strong operating link to the UK. Companies will therefore have to consider what this means for their balance sheets both from an accounting, cash flow (e.g. bank borrowing) and tax perspective. Some companies may consider (upfront) changes to their current business model as a consequence. This may result in additional tax considerations around business restructuring rules. While the actual legal changes will only become clearer once the negotiations between the UK and the EU have started, a restructuring which is conducted within the next 2 years while the UK still belongs to the EU may benefit from a more favourable tax treatment than a restructuring which is undertaken once the UK is out. In summary, the area of direct taxation will be affected by the decision of the UK to leave the EU. Most consequences will come to light when the negotiations on the exit and on the subsequent UK-EU relationship have become clearer. However, business should already consider the impact of these changes when new investments are made, in order to structure investments as Brexit proof and minimise, for example, withholding taxes. In addition, we recommend businesses to consider their current corporate structure to determine which impact the changes may have and how the negative consequences can be mitigated. PwC Brexit Monitor - Issue 4, July

11 Tax The takeaway Businesses should start assessing factors which will be of particular relevance to their tax position upon a UK exit from the EU. In most cases, immediate action is not necessary to prevent negative tax consequences but there is an urgent need to be as fully informed as possible, show awareness and ensure good communication with employees, your supply chain and other stakeholders. In addition, when new investments are made or corporate reorganisations take place, we recommend to keep forthcoming changes at the back of your mind to make sure that your corporate structure is, in as far as it is possible, Brexit proof so that the potential tax consequences are minimised. Both the EU and the UK government have appointed their Brexit teams to consider the breadth of issues that need to be considered in withdrawal negotiations and consequential policy changes. In the UK business will be consulted in this regard, and we would encourage companies to engage in the process and make their concerns and preferences known. Similarly on the European side, policy makers would need to hear the voice of business on the EU-UK exit negotiations. Some of the discussions taking place may lead to a wider policy debate and more long-term directional change. While focusing on the present and shortto medium-term aspects of cost control etc., businesses should also think about longer-term strategy and the impact of tax. In this Brexit Monitor, we have paid special attention to the potential tax impact of the UK s decision to leave the EU. As may be known, there are many current ongoing initiatives in the field of international taxation such as the Base Erosion and Profit Shifting (BEPS) initiative of the OECD and the Anti-Tax Avoidance Directive of the EU. In determining a tax strategy for the following years, business should consider all these elements to have a balanced position reducing negative impact and making use of opportunities that we are sure will also surface. PwC Brexit Monitor - Issue 4, July