Yes, we’re talking about the British exit from the European Union. We are not sure why the media coined the term “Brexit,” when it’s not only Britain (England and Wales) that voted, but the United Kingdom, which includes Great Britain, Scotland and Northern Ireland, with the latter two not referring to themselves as “British.” But we digress. While the UK didn’t buy into the monetary union and continued to use the Pound Sterling as its currency, it played an active and necessary role in the EU.
With the June 23rd vote to exit the EU, there seem to be more questions than answers.
But first, some facts:
Per the BBC, England voted strongly for Brexit by a 53.4 percent to 46.6 percent margin. Wales had a similar outcome, 52.5 percent to 47.5 percent. However, Scotland and Northern Ireland both voted to stay, with Scottish supporters garnering 62 percent and Northern Ireland supporters reaching 55.8 percent.
What Scotland and Northern Ireland have in mind is unclear. If they prefer to remain part of the EU, as some suggest, will they also want to remain a part of the UK? Or will Scotland and Northern Ireland continue to push for autonomy? The UK has two years to negotiate its withdrawal. While a lot can happen in that timeframe, let’s assume the UK truly exits. What’s next?
What’s the Future of the UK?
Suppose Scotland and Northern Ireland secede from the UK. As far as the tax world, they currently operate under the UK system. Note the tax treaty that people often refer to as the “UK-US tax treaty” is called Convention between the Government of the United States of America and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains. So, the treaty is with all of the UK: Great Britain (England, Scotland, Wales) and Northern Ireland. If Scotland and Northern Ireland leave the UK, presumably the treaty wouldn’t apply to their residents. Instead, they would have to negotiate their own tax treaties. (When Hong Kong became part of China, it did not become part of the China-US tax treaty.) In another example though, the treaties with the USSR and Czechoslovakia were extended for a period of time to the states included in each prior to their break-ups into separate sovereign states.
If you’re a US company with a parent, subsidiary or affiliate in Scotland or Northern Ireland, it may be wise to examine your structure and costs in any potential reorganization. One must bear in mind that the “clock does not begin to tick” until the UK invokes Article 50 of the EU treaty, giving official notice of its exit. Once invoked, it will take at least two years to fully complete the exit. Depending on the impact and cost, we envision that companies may choose to relocate to ensure treaty benefits.
How Will Customs Duties Change?
Once the UK exits, the EU customs duties rules will no longer apply. So, absent trade agreements between the UK and the EU or its members, there are likely to be duties charged on UK-EU trade. The UK may also enter agreements with other countries and/or trade blocs. In theory, UK-EU negotiations would lead to small, if any, duties, but the administrative headaches could be substantial. Furthermore, any trade agreements between the EU and other non-EU countries may be affected and/or subject to renegotiation.
Base Erosion and Profit Shifting (BEPS)
The Organization for Economic Cooperation and Development has been pushing its BEPS initiative. Presumably the UK’s exit won’t have a direct impact at the OECD level. However, the UK would arguably be unable to influence EU tax (or any other) policy. This could be important as the EU is the bloc pushing hardest for BEPS implementation. As an aside, the US Treasury has expressed strong reservations about certain BEPS aspects and perhaps can use the UK as an ally: however, the UK was one of the first countries out of the gate to implement a BEPS provision called the Diverted Profits Tax (termed by some as the “Google” tax). The Treasury not only took exception to its passage but is still considering whether it is a creditable tax for US tax purposes.
Value Added Tax (VAT) VAT or similar indirect taxes are almost omnipresent outside the US. Each EU member has its own VAT law which includes certain provisions that take into consideration the free movement of goods and services between the member states, Such provisions will exclude the UK. In any case, there are more likely to be administrative costs far above and beyond those that exist today, Companies importing into and/or exporting from the UK should begin to consider alternative flows of goods and services depending on the final outcome of the exit and any potential amendments to the UK’s VAT law. Again, it's far too early to tell or make material decisions. Based on our experience, reviewing product/services flow is a value-added service in its own right as companies often find they’re not always operating as planned and/or don’t have a strong grasp of precisely how.
Intra-EU Cash Flows.
The EU Parent-Subsidiary-Directive is a participation exemption regime allowing dividends to pass tax-free from one EU company to another. The UK won’t benefit from this directive post-exit and would then need to rely on its tax treaty network to keep dividend withholding low. This is critically important to UK companies investing in the rest of the EU since any withholding results in a net cost because the UK exempts certain dividends from foreign subsidiaries received by UK parent companies. Although the EU directives also include an exemption from source withholding for interest and royalty flows, the impact is minimal since such income is taxable in the hands of the UK beneficial owner who should be able to obtain a foreign tax credit for the taxes withheld. Bear in mind that the UK has separate tax treaties with most, if not all, of the members of the EU.
Corporate Income Tax Rate.
The UK has been cutting its corporate tax rates. Will it further do so and compete with, say, Ireland and its 12.5 percent rate? Will the exit prompt the EU to more quickly harmonize its tax rates, or will it lead to more squabbling and disagreement? Or will the status quo of ‘two-steps-forward, one-step-back” hold?
Mergers & Acquisitions.
M&A thrives on opportunity, and uncertainty generally acts as a brake on such activity. With the Pound Sterling end US Treasury Bonds showing material drops the day after voting, we’ve got unrest in global markets. There’s currency volatility and market uncertainty, arguably leading to reduced MM activity for the faint of heart. The tax uncertainty doesn’t help and may wreak havoc with financial calculations and valuations for M&A candidates, On the other hand, those with higher risk tolerance may have great opportunity.
Free movement of people.
With the exit, companies on both sides of the divide may find it more difficult and costly to move personnel between the UK and other EU member states.
Future of EU.
With other countries also try to leave the EU? Some commentators have posited that the negotiations will be very difficult and the major (France and Germany) EU members will want to send a strong message that it will be costly to any other countries that are contemplating an exit.
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