1 March 2016 Global Tax Alert UK to hold referendum on its membership of the European Union EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: www.ey.com/taxalerts Executive summary It has been confirmed that a referendum on the UK s membership of the European Union (EU) will be held on Thursday 23 June 2016. In that referendum, voters will be asked Should the United Kingdom remain a member of the European Union or leave the European Union? British, Irish and Commonwealth citizens over 18 who are resident in the UK will be eligible to vote, along with UK nationals who have lived overseas for less than 15 years. This means citizens from EU countries who are resident in the UK - apart from those from Ireland, Malta and Cyprus - will not get a vote. Detailed discussion What has triggered the referendum? As part of the Conservative Party manifesto for the 2015 general election, the Prime Minister, David Cameron, promised to negotiate a new settlement for Britain in Europe, and then ask the British people: do you wish to stay in the EU on this basis, or leave? On 10 November 2015, David Cameron set out his goals for reforming the UK s membership of the EU in a letter to the President of the European Council. The subsequent negotiations between the UK Prime Minister and EU leaders, which concluded at the European Council meeting on 18 and 19 February 2016, resulted in an agreed package of changes to the UK s membership.
2 Global Tax Alert These changes include a Decision by the heads of the Member States which states that measures to further deepen economic and monetary union will be voluntary for member states whose currency is not the Euro and recognizes that the UK is not committed to further political integration into the EU. This is accompanied by a draft Council Decision on specific provisions relating to the effective management of the banking union and declarations on competitiveness, social benefits and freedom of movement. The arrangements would take effect should the UK vote to Remain in the EU. The arrangements are intended to be legally binding and subject to amendment only by unanimous agreement by the Member States. What happens if there is a vote to Leave? There is as yet no set procedure or timetable for what would happen should the UK vote to Leave. No Member State has yet left the EU (and there is only limited precedent in respect of the European Economic Community). Article 50 of the Treaty of Lisbon includes provisions applicable where a Member State notifies the European Council of its intention to leave the EU. It provides for the EU to negotiate and conclude an agreement with the Member State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. Article 50 also notes that the European Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period. In the period of any negotiations under Article 50, the UK would retain its EU rights and privileges, though it would be excluded from the European Council when matters directly pertaining to the negotiations are being considered. The Prime Minister has stated that Article 50 is the only way to begin the process of exit. The UK Government has now published a document setting out the process that the Government would follow after a vote to leave the EU. That document reiterates the Government view that Article 50 is the only lawful way to exit the EU while also setting out the prospects for the negotiations that will be necessary. However, campaigners to Leave have suggested that the UK would not necessarily have to use the Article 50 process and could agree a separate process. What tax implications might a vote to Leave have? If the UK were to make a clean break from the EU it could rely on its membership of the Word Trade Organization as the basis for trade. However, this would mean that the UK would be subject to the EU s Common External Tariff alongside possible non- tariff barriers and would possibly wish to impose tariffs of its own in dealings with the EU. The need to address the question of tariffs suggests that the UK will look to negotiate some form of new trading model (see below). In terms of taxation, the main areas of EU influence are in relation to indirect taxes, particularly value added tax (VAT) and excise duties which are the most harmonized. Under the current rules, the form of VAT that the UK operates is prescribed by the EU rules. This means that the UK cannot introduce new zero rates (as popular petitions have called for), cannot introduce an additional turnover tax (limiting options for the replacement of business property rates) and has been forced to change its tax system to align with the interpretation of Europe (in such industries as betting and gaming and insurance). Excise duties are not harmonized to the same extent as VAT but are still governed by EU rules. Although direct taxes are a matter for the member states themselves, there is relevant EU legislation in the form of EU Directives and the State Aid regime which the UK needs to comply with. The EU Directives include: Merger Directive: In the case of mergers involving a company transferring assets and liabilities to one or more companies in a different EU member state, the Directive provides for a deferral of the taxes that could be charged on the difference between the market value of such assets and liabilities and their value for tax purposes, subject to certain conditions Parent-Subsidiary Directive: This abolishes withholding taxes on qualifying payments of dividends between associated companies of different Member States and prevents double taxation of parent companies on the profits of their subsidiaries Interest and Royalties Directive: This is designed to eliminate withholding tax obstacles in the area of cross-border interest and royalty payments within a group of companies EU Capital Duty Directive: This essentially prohibits Member States from taxing the raising of capital
Global Tax Alert 3 Directive on administrative cooperation in the field of taxation: This provides for the automatic exchange of financial account information between tax authorities of member states using the Organisation for Economic Co-operation and Development s (OECD s) common reporting standard (CRS). The CRS has effect in the UK from 1 January 2016 The restrictions on State Aid apply to all forms of aid, whether provided through the tax system or through spending initiatives. Under these rules, aid cannot be provided on a selective basis unless it falls within a clear set of exemptions (e.g., for small business or for innovation). More generally, the UK is required to exercise its power to tax consistently with EU law and in particular with the four fundamental freedoms being: Free Movement of Goods Freedom of movement for workers Right of establishment and freedom to provide services Free movement of capital This has led to a number of elements of the UK tax system being found to be in contravention by the Court of Justice of the European Union and requiring changes to be made. This has included restrictions in the UK s application of exit taxes, the way in which it applies transfer pricing and limits on antiavoidance rules (such as those governing controlled foreign companies). If the UK were to leave the EU, then it would have greater potential to amend UK tax law in the future without EU constraints. In practice, many of the constraints are ones that the UK would want to continue. However, the flexibility might be used as follows: To provide State Aid if desired To change the structure of VAT To introduce specifically targeted anti-avoidance To focus incentives, such as research and development, only on UK activity To impose exit taxes on departure from the UK There may of course be costs to the Directives ceasing to apply to cross-border transactions with the UK, such as withholding tax imposed by other countries, where the relevant double tax treaty does not provide the same protection as a Directive. In any event the UK would still be subject to other international influences such as the World Trade Organization and any anti-discrimination provisions in its double tax treaties. Notably, it would remain influenced by the OECD which, together with the G20, has driven the recent agreement on automatic exchange of information, and is currently driving the Base Erosion and Profit Shifting (BEPS) project. As a non-eu member, the UK may however have scope to implement the BEPS recommendations outside the common approach proposed by the European Commission and outside the EU fundamental freedoms. What alternatives might the UK look to negotiate? Whatever process is followed for any exit from the EU, it seems likely that the process would involve negotiation of the UK s access to the Single Market. At the same time, the UK would need to negotiate trade agreements with non-eu territories, as it would not inherit the EU s bilateral trade agreements. The UK Government has promised to publish its views on alternative models for the UK s relationship with the EU after exit. To date, three principal models which have been cited are: The European Economic Area (EEA) model. This would offer the UK access to the Single Market for goods and services without having to participate in either the Common Agricultural Policy (CAP) or fisheries policy. The UK might also be able to benefit from the EEA/European Free Trade Agreement trade agreements with other countries, though this may still require negotiation. However, the UK would have to accept Single Market rules without any significant ability to participate in their creation. It is likely that it would have to accept free movement of labor, accede to Schengen in respect of border controls, and pay both an EEA grant and contributions to certain EU programs, Admission to the EEA would need the conclusion of an accession treaty by the UK and each of the thirty EEA Member States (including the twenty seven from the EU) A customs union (the Turkish model ). This could be based around a limited customs union allowing tariff free access to EU markets but with little say in drafting the rules and regulations with which the UK would have to comply to retain access. A UK version of this could possibly be broader and deeper than the arrangements with Turkey
4 Global Tax Alert A bespoke bilateral arrangement (the Swiss model ). The Swiss relationship with the EU is based on a series of bilateral sector agreements. Not all sectors are covered (there is little agreement on financial services for example) and Switzerland has no agreement with the EU on services Alternatively, the UK may hope to negotiate a comprehensive free trade agreement, which does not require agreement to free movement or budgetary contributions. It can be expected that as part of any deal with the UK, the EU would make demands on regulation: the deeper the agreement, the more EU regulation the UK would have to accept. In this scenario, the UK would still need to negotiate its own trade agreements with non EU countries. It has been suggested that, following a vote to Leave, instead of exiting the EU, the UK could seek to negotiate a special member status. Under this proposal, the UK could legally remain a Member State of the EU, while a revision of the EU treaties could allow the UK to continue to participate both in the internal market and in the corresponding EU decisionmaking process, while obtaining the right not to participate in certain EU policies. The current EU treaties do not allow for such a status and any change to the treaties could be seen by other Member States as compromising the EU project and opening up opportunities for more euro-sceptic debate. With all of the options set out above, there is no certainty as to how negotiations would progress. Implications Over the coming months, the arguments for and against the UK remaining in the EU will be developed and groups will wish to assess their exposure and opportunities, depending both on the result of the referendum and any subsequent developments. Groups may wish to assess their supply chain and how it might evolve, taking account of changes that may arise from a vote to Leave, including: The impact of tariffs and non-tariff barriers Introduction of withholding taxes Restrictions on movement of people (together with any changes in social security arrangements) Whether current EU passporting rights would be lost, and, if so, what if any rights would replace them The additional flexibility the Government will have to determine tax policy as it may no longer need to comply with EU laws such as those on State Aid and the four freedoms (depending upon the terms agreed for the UK s exit) They may also wish to consider how the combination of any Brexit and the upcoming implementation of the OECD BEPS recommendations may impact on their group structure. In this regard, should there be a vote to Leave, there may be a short window to contribute to discussions on the need for competitiveness in the UK Government s tax policy in any new business environment after the referendum. For additional information with respect to this Alert, please contact the following: Ernst & Young LLP (UK), London David Evans, Corporate Tax +44 20 7951 4226 devans@uk.ey.com Mark Persoff, Corporate Tax, Financial Services +44 20 7951 9400 mpersoff@uk.ey.com Arjen Odems, Customs & Duties +44 20 7951 1446 aodems@uk.ey.com Ian Dawes, VAT +44 20 7951 5367 idawes@uk.ey.com Mike Kenyon, Social Security +44 20 7951 2583 mkenyon@uk.ey.com Claire Hooper, Technical Tax Policy & Knowledge +44 20 7951 2486 chooper@uk.ey.com Chris Sanger, Global Tax Policy +44 20 7951 0150 csanger@uk.ey.com Ernst & Young LLP, UK Tax Desk, New York Matthew Newnes +1 212 773 5185 matthew.newnes@ey.com
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