Legal Brexit: Corporate Tax

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1 Legal Brexit: Corporate Tax Graham Aaronson QC, Simon Whitehead, Paul Farmer and Michael Anderson Originally printed in Chambers Global Practice Guides: Legal Brexit 20 September 2016 Current Legislative Framework This article considers how UK corporates will be affected by Brexit from a tax perspective. Its focus is on the manner in which multinational companies (both within and outside the EU) have been able to benefit from EU rights in direct tax situations. It then considers the vexed question of the future for value added tax (VAT). Direct tax has generally lacked any significant EU legislation so that reliance on EU law has generally required invoking rights derived from the EU Treaty itself: these are the fundamental freedoms of free movement of goods, freedom of establishment, free provision of services and free movement of capital and payments. Until the current raft of directives within the 2016 EU Anti-Tax Avoidance Package, EU direct tax legislation has been effectively limited to a handful of provisions (the Parent-Subsidiary Directive (90/435/EEC; 2003/123/EC), the Merger Directive (90/434/EEC; 2005/19/EC), Interest and Royalties (2003/49/EC), Taxation of Savings Income (2003/48/EC) and Capital Duties (69/335/EEC)) clearly reflecting the challenges of obtaining unanimity between Member States in the area of direct tax. The Common Consolidated Corporate Tax Base proposal, to which the UK was vehemently opposed, has been languishing for many years. Perhaps its 2016 revival (within the context of the 2016 Anti- Tax Avoidance Package) might actually benefit from Brexit. The move towards harmonisation in respect of VAT was initiated by way of the First VAT Directive in 1967 and later, in 1977, a substantive VAT Directive (Council Directive 77/388/EEC) was enacted. This VAT Directive has been updated with its most recent version being in 2006 (Council Directive 2006/112/EC). However, as with most areas of tax law, it is the case law which gives life to the bare bones of the VAT Directive. Direct tax The burgeoning understanding that treaty rights could nevertheless be invoked in a direct tax context commenced with the ECJ s seminal judgment in 1986 in Commission v France ( Avoir Fiscal ). Avoir Fiscal meant that, for the first time, taxpayers could rely on the EEC Treaty itself, a superior norm, to dis-apply domestic tax legislation which, discriminatory in nature, restricted their fundamental freedoms. From then on, the concept of unfettered fiscal sovereignty had to be reconsidered. Whilst the ECJ had asserted its authority at the very early stages of what is now the EU, and had repeatedly sought to ensure harmonisation in the realm of indirect tax, it was not until 1986 that the Member States had to acknowledge that direct tax measures could also thwart the aims of the Single Market. From a practitioner perspective, this has created an exciting practice area out of contentious tax where the sums in question are often colossal.

2 In the 30 years that have followed, taxpayers and the European Commission have regularly challenged Member States and, to a large extent, with considerable success. This process of negative integration created propitious conditions for intra-eu and inter-eu direct investment as investors were reassured that they would not suffer onerous tax conditions by virtue of their place of tax residence. Many would consider that the ECJ s role has been to remove the last significant barrier to trade within the Single Market by ensuring a more level playing field. The situation in the UK was no different. Over the last three decades, companies and individuals successfully challenged discriminatory UK legislation in respect of various administrative and substantive tax measures, ranging from the denial of repayment supplement to non-residents (Commerzbank) to the restrictions on consortium relief and domestic and cross-border group relief for EU residents (ICI v Colmer, Philips Electronics and Marks & Spencer), controlled foreign company charges (Cadbury Schweppes) and the Advance Corporation Tax regime and taxation of dividend income (Hoechst, Pirelli and the FII and CFC and Dividend GLOs). Far from being judgments giving effect to nebulous and commercially valueless rights, the ECJ s rulings have cleared the path for economic growth within the UK and the EU as a whole. The decision in Philips Electronics and the subsequent legislative amendments ensured that UK subsidiaries of an EU-resident parent company were able to enjoy the same cash-flow advantages as those which comparable groups wholly based in the UK could enjoy, as a result of consortium relief. Its decisions on the UK s dividend tax regime ultimately led to its repeal and replacement with an exemption system consistent with that of almost all countries. Similarly, the European Commission has played a key role in ensuring that UK tax legislation complied with the relevant EU treaty in force at the time. For example, it was an investigation by the European Commission into the, now repealed, s. 739 legislation that led to a reform of the legislation resulting in the current Transfer of Assets Abroad legislation (Income Tax Act 2007, Part 13, Chapter 2). All things considered, even if there is a relative paucity of EU legislation specifically and exclusively pertaining to direct taxation, the strong position taken by the ECJ and the European Commission to remove discriminatory tax measures has allayed the concerns of multinational enterprises wishing to invest in the EU. Transitional Framework From a legislative perspective, the UK may wish to consider introducing legislation to retain some (if not all) of the EU directives. Given the European Commission s strong and swift actions against tax avoidance by multinationals and the fact that many multinationals with operations in the EU have UK headquarters, it is not unforeseeable that the UK s co-operation on tax information exchange and mutual exchange may be exacted as part of any future bilateral trade agreement. Accordingly, the UK may be compelled to agree to provide information to the remaining EU Member States (eg the recent amendments to the Administrative Co-operation Directive to provide for the automatic exchange of tax rulings and advance pricing agreements). Post-EU Exit Were the requirement of the UK to observe the fundamental freedoms of movement to be removed entirely, in theory tax measures which imposed higher tax burdens on overseas investment might return. This could include the old restrictive controlled foreign companies legislation (found

3 incompatible with EU law in the Cadbury Schweppes case) or the return of tax on dividend income with credit for foreign tax limited to that required in double tax conventions (found incompatible with EU law in the FII litigation), resulting in a system where the UK granted only credit on portfolio investments for withholding tax. We might even see the return of the partial imputation system (ACT), found unlawful in Hoechst and following cases, which imposed a secondary level of tax on foreign income not imposed on domestic investments. The argument would be, of course, that such restrictive measures would inhibit investment and trade, but, equally, those arguments were raised at the time. In several instances, it was only the involvement of the ECJ that precipitated liberalisation. The UK leaves the EU but remains part of the EEA If the UK were to leave the EU but remain a member of the European Economic Area (EEA), the landscape would largely be the same the fundamental freedoms will apply such that HMRC will be, in part, stymied from radically overhauling domestic legislation. However, key rights pronounced by the ECJ may not necessarily find an equal place in the European Free Trade Association (EFTA) Court, which provides guidance on the EEA Agreement in a similar way to the ECJ in relation to the EU Treaty. It is possible that the principle of effectiveness may not be available to the same extent as under the current case law of the EU. A key disadvantage would be the removal of the EU Charter of Fundamental Freedoms, which is not applicable within the EFTA. As one Norwegian Supreme Court judge noted, for the EFTA Court to define rights by analogy to the EU Charter would represent a not so substantial judge-made amendment to the EEA Agreement. The UK leaves the EU but joins EFTA Switzerland is a member of EFTA, but is not a Contracting Party to the EEA Agreement (which allows participation in the EU s Internal Market), instead having a series of bilateral agreements with the EU. This would reflect the UK s position, provided the UK could negotiate similar bilateral agreements. Given the Commission s recent statements, this may not be possible and the UK, as a member of EFTA but not the EEA, might be left solely with the benefits of the free trade agreement with Iceland, Norway, Liechtenstein and Switzerland. The UK leaves the EU and trades with the EU Whither UK VAT? There may be few differences between different post-eu arrangements from a VAT perspective. The most obvious question for practitioners following the referendum in the UK is whether there will be a VAT following the UK s departure from the EU. VAT is often described as a regressive tax because it taxes consumption, and the percentage of income used to purchase goods and services tends to fall as income rises, but what would its abolition mean? Annual VAT receipts are at a peak of billion, which represents 6.1% of the UK s forecast GDP (HMRC Tax & NIC Receipts monthly and annual historical record, 21 June 2016 ( data/file/532373/may16_receipts_ns_bulletin_final2.pdf)).

4 To put this into context, VAT accounted for 22% of HMRC receipts in , whilst corporation tax, petroleum revenue tax and the banking levy accounted for a mere 9% of receipts (ibid). VAT receipts could fund the NHS for almost a year. For 2015/16, the overall NHS budget was around billion. See About the National Health Service ( The UK pays over only a very small proportion of the harmonised VAT base to the EU and it seems inconceivable that the government would now wish to lose out on this valuable source of revenue. Customs duties are currently not nearly as significant, even if one assumes that the UK will retain 100%, rather than paying a proportion over to the EU. It is therefore highly probable that the UK will retain a broad-based multi-stage tax on final consumption and, since the UK is a member of both the Organisation for Economic Co-operation and Development (OECD) and the World Trade Organization (WTO), this tax is likely to aim for neutrality not only domestically but also in international trade. To that end, it will incorporate the international norm and WTO-sanctioned destination principle, whereby tax is ultimately levied on the final consumption that occurs within the taxing jurisdiction. The WTO s Agreement on Subsidies and Countervailing Measures specifically carves out from the concept of a subsidy the exemption of an exported product from duties or taxes borne by the like product when destined for domestic consumption, or the remission of such duties or taxes in amounts not in excess of those which have accrued. See also Article 15 of the Agreement on the European Economic Area. The courts approach and the new VAT policy space The UK s VAT legislation is currently based on the EU legislation, but the UK may be able to retain its existing domestic legislative framework for VAT, albeit with some adaptations and exceptions. Section 3(1) of the European Communities Act 1972 currently requires questions of EU law to be determined in accordance with the principles laid down by, and any relevant decision of, the European Court. If it is repealed, the obligation of courts in the UK to interpret that VAT legislation in conformity with the VAT Directive will fall away. This principle derives from Case C-106/89 Marleasing S.A. v La Comercial Internacional de Alimentación S.A. [1992] 1 C.M.L.R. Even if the status of EU judgments to date is not put on a new statutory footing, the EU legislative framework or case law may not become completely irrelevant because they may shed light on Parliament s intention in enacting certain legislation. Exactly how significant these aids to interpretation will be remains to be seen. Once the UK has left the EU, there will be much more flexibility to make policy decisions on minimum and maximum rates, reduced rates and exemptions. By way of example, the recent case on outsourced insurance claims handling services Case C-40/15 Minister Finansów v Aspiro S.A. [2016] S.T.C revealed a disparity between the UK s domestic treatment and the EU interpretation, which has concerned the London insurance market. HMRC is expected to react to this judgment shortly. It will be interesting to see how the government intends to approach this issue, knowing that, for the time being, it is required to bring UK legislation into line with EU requirements, but that in the longer term it could take a different policy decision. Depending upon the model adopted and even if that is WTO only the UK s freedom will not be entirely unfettered. For example, from a WTO perspective, preferential VAT rates for domestically

5 manufactured raw materials or components might be problematic, as recent disputes between China and the US demonstrate. Furthermore, although the EEA Agreement (the model Norway adopts) does not require VAT harmonisation, Article 14 would also prevent such preferential measures (see also Article 4 of the EFTA Convention). Some selective VAT exemptions for goods or services may also give rise to state aid issues (see EFTA Surveillance Authority Decision No 193/14/COL of 8 May 2014 concerning certain amendments to Act No 50/1988 on Value Added Tax applicable to customers of Icelandic data centres). Compliance: complexity and cost for taxpayers and tax administrations A key change that the UK will need to make to its VAT legislation will be to the place of supply rules for both goods and services. The distinction between supplies to or from the EU on the one hand and to or from "third countries" on the other will no longer exist for this purpose. Unless the EU suggests a wholly new approach, that will hold true whether the UK pursues the Norwegian, Swiss or some other model for its relationship with the EU. One obvious point arising out of this, apart from the increased complexity of export and import compliance as against that for intra-eu trade, is that goods imported into the UK from EU countries are now likely be subject to import VAT, calculated on top of any customs duties that may be due. (Customs duties are beyond the scope of this article. However, it should not be assumed that they will not be an issue. Taking the Norwegian model as an example, the EEA Agreement does not provide for the free movement of all goods. In particular, the EEA Agreement does not cover the EU s Common Fisheries and Agricultural Policies.) By contrast with acquisition VAT, which is accounted for on the VAT return, import VAT must actually be paid at the time of importation, unless the importer (or their agent) is approved for deferment. A guarantee is required to operate a deferment account, which is an additional cost, although there is a Simplified Import VAT Accounting Scheme available for traders with a good compliance history that enables them to reduce the level of financial guarantee required for VAT (but not for customs or excise duties). Import VAT thus either represents an additional cash-flow cost to businesses or means that businesses need to incur additional costs to secure financial guarantees from banks or insurance companies. It also seems likely at present that UK-established suppliers of digital services to private individuals in other EU Member States and non-eu suppliers which are registered through the UK s VAT Mini One Stop Shop ( MOSS ) may in due course have to choose another EU Member State to fulfil their VAT accounting obligations or register in each Member State where they have non-business customers. Another obvious point, equally applicable to goods and services, is that the EU has in place a number of reporting and information mechanisms, such as Intrastat, various Sales Lists, VAT returns and the VAT Information Exchange System ( VIES ), which facilitate the monitoring and control by VAT administrations of the flow of intra-eu trade. Council Regulation (EU) 904/2010 of 7 October 2010 provides for the electronic sharing of information obtained in this way and more administration cooperation besides, all geared towards fighting VAT fraud. Without this information, it will become more difficult for the VAT administrations to check that the correct VAT treatment has been applied, particularly in the case of services which do not have to cross a physical frontier, a reality that was perhaps less important when the UK first introduced VAT. In recent years the European Commission

6 has proposed stronger co-operation with non-eu countries such as Norway and Russia on VAT, so perhaps the EU and the UK will seek to negotiate an information-sharing deal for the future as part of the UK s exit package. With the best will in the world and even if the UK aims to abide by the OECD International VAT/GST Guidelines, Brexit may result in more instances of double or non-taxation, which may require some creative thinking on appropriate dispute resolution mechanisms. This is likely to become more acute as the UK system develops its own case law. For example, the classification of supplies (and, as a result, their place of supply) may change over time and diverge from the EU model. However, depending upon the exact circumstances of a case, EU VAT dispute resolution mechanisms may remain relevant and useful from a UK perspective. Thus, for example, domestic legal proceedings in an EU Member State could still generate a reference to the Court of Justice, whilst businesses which have VAT registrations in one of the 17 other EU Member States participating in the cross-border VAT ruling pilot could still avail themselves of that. Expertise will need to develop in other areas too. There may be an increased requirement for defence against allegations of fraud or securing supply chain integrity. More than anything, practitioners will need to be alert to the broader principles of international trade in goods and services in order to achieve the best results for businesses.