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Tom Roth and Mark Bevington, Baker & McKenzie, London
Tom Roth is a Senior Associate and Mark Bevington is a Partner at Baker & McKenzie
Since the U.K.’s referendum on June 23, the question of what Brexit actually means has elicited a variety of conflicting responses. The following article considers the opportunities to reshape the U.K.’s tax policy without the constraints exerted by the European Union.
Beyond his stated plans to “reset” the British economy following Brexit, the precise shape U.K. tax policy will take under Philip Hammond's economic stewardship remains uncertain. Should the new Chancellor's approach follow that of his predecessor—to leverage Brexit as an opportunity to “make the UK the most attractive place in the world to do business”—then associated questions arise. Principally, could the post-Brexit trajectory of U.K. tax policy offers greater opportunities for U.K. legislators to improve tax competitiveness to attract investment into the U.K. than the non-Brexit trajectory that would have otherwise existed and if so, what measures will be implemented?
While domestic political pressures deriving from increased public interest in the tax affairs of multinationals has acted as a catalyst to drive U.K. pre-Brexit tax reform, the shape of this reform has been largely driven by the countervailing external influences of the OECD's BEPS Action Plan and EU tax policy.
From an EU law perspective, the fundamental freedoms have until recently acted as a liberalizing force on U.K. tax policy. Various EU cases over the last three decades have led to the introduction of and extensions to the U.K. group relief, cross-border loss and consortium relief rules. EU case law has also informed amendments to the U.K.’s Advance Corporation Tax, foreign dividend taxation regimes and CFC rules. Overall, such cases have assisted in levelling the U.K. playing field for EU companies and, in doing so, have improved the competitiveness of the U.K. tax system for foreign investment. Additionally, EU policy appears to have shifted towards building upon the OECD's work on BEPS and countering avoidance.
More recently, changes to U.K. tax policy have been shaped by the OECD BEPS Action Plan. The U.K. Diverted Profits Tax (or DPT), anti-hybrid rules, changes to interest deductibility rules, expanded definition of royalties and new royalty source rules have all been BEPS-inspired measures. With the possible exception of Australia, the U.K. has acted more quickly than any other country to implement some of the key BEPS Actions.
The contrasting effects of these influences have produced a tension between the EU's historic influence of liberalizing the U.K. tax system and the OECD's and EU's current influence of policing and restricting certain tax structures. This tension between tax competitiveness and tax policing becomes more pronounced when set against recent U.K. domestic reforms to improve tax competitiveness.
However it is within this tension that we find our snapshot of the U.K.’s pre-Brexit tax policy trajectory—a tax system liberalized by the EU and a domestic commitment that it should be “open to business”, but also a system that has to co-exist with a post-BEPS global tax paradigm. This tension has translated to a “carrot and stick” approach to U.K. policy—one that with one hand incentivizes multinationals to shift substance to the U.K. through reducing their effective tax rate, while with the other hand polices behaviors that see U.K. profits from that substance artificially diverted offshore. In other words, the U.K. government has promoted itself as the most tax competitive “substance jurisdiction” in the world through encouraging multinationals to bring profits to the U.K., provided that those profits are taxed in the U.K.. The speed at which the U.K. government has implemented this approach places it at a significant “first mover” advantage in what is ultimately a global battle for substance.
The U.K. government has acknowledged that Brexit represents a difficult structural change to the U.K. economy. Improved tax competitiveness may provide a significant buffer against any short- to medium-term economic turbulence experienced by the U.K. economy.
The post-Brexit trajectory of U.K. tax policy is therefore likely to be informed by measures that attempt to improve tax competitiveness to stimulate economic growth. If the introduction of such measures continues to be framed by the pre-Brexit “carrot and stick” approach to attracting substance into the U.K., the next logical question is to what extent can the UK introduce further “carrots” (or, alternatively, to what extent does it avoid certain “sticks”) following Brexit. A related question is whether the exit from the EU helps or hinders the U.K.’s ability to adopt these “carrot” or “stick” strategies?
The U.K. government is currently in “listening mode” in terms of the positive measures it may take to improve tax competitiveness post-Brexit. Some possible measures it may take in this regard include:
Another possible measure that has previously been floated is a further reduction in the corporate tax rate. In the days following Brexit, former Chancellor George Osborne flagged a possible reduction to 15 percent, however there is no positive indication Philip Hammond will do anything but leave the reduction on its current trajectory to 17 percent from April 2020. This would still leave the U.K.’s rate significantly below the current EU average rate (22.5 percent), on par with the Singaporean headline corporate rate (17 percent) and within striking distance of various Swiss cantonal rates and Irish rate.
Beyond these positive steps to improve tax competitiveness, the fact that the U.K. will no longer be required to implement certain EU-dictated tax measures could enhance its attractiveness.
Historically, EU Membership has had a positive impact on U.K. tax competitiveness, but more recently EU tax reform has been more focused on policing measures—some of which have been aligned with the BEPS actions, but also other measures going beyond BEPS.
The most immediate illustration of such a Brexit benefit is in relation to the adoption by the EC of the Anti-Tax Avoidance Directive (“ATAD”). While the U.K. agreed to the ATAD pre-Brexit, as the ATAD will not fully come into force until December 31, 2019, it is unlikely that it will be implemented into U.K. law.
So how would the U.K. not adopting the ATAD improve U.K. tax competitiveness? The ATAD proposes a number of measures, some of which are influenced by the BEPS recommendations but with other measures that go further. One such measure is the introduction of a market-value based exit tax on the transfer of assets from head office to permanent establishment in another member state (where the member state no longer has the right to tax profits arising on those assets). Currently, many EU jurisdictions provide for deferral of such an exit charge (potentially indefinitely). The U.K. offers a 10-year deferral, however the ATAD tightens EU deferral regimes to five years and interest may be charged on deferred exit amounts. Additionally, the ATAD introduces various triggers that crystallize a deferral charge if, amongst other reasons, the transferred assets are disposed of or the taxpayer migrates to a third country. The absence of a more restrictive deferral regime in the U.K. may place the U.K. at a distinct advantage versus its EU counterparts (and other holding jurisdictions, such as Switzerland that impose exit charges) through providing greater flexibility on a later exit from the U.K. should future circumstances warrant it. It also offers the optionality for the U.K. to extend the deferral period, allow for a permanent deferral or get rid of an exit charge altogether.
The ATAD also contains a broad general anti-abuse rule that requires member states to ignore arrangements or a series of arrangements which, having a main purpose of obtaining a tax advantage that defeats the purpose of the applicable tax law, are not genuine having regarding to all the facts and circumstances. While the U.K. has a GAAR, it is narrowly targeted at the most abusive arrangements. The ATAD proposal is much wider than the U.K. GAAR, and therefore if the U.K. retains its narrow focus it will have a competitive advantage over EU member states, not least because of the uncertainty that initially arises from broader and more loosely defined anti-abuse rules.
Another EU measure that the U.K. would no longer be required to implement post-Brexit is the adoption of the proposed European Consolidated Corporate Tax Base (“CCCTB”) Directive. While it is not clear whether the adoption of the CCCTB would have restricted the U.K.’s ability to reduce its corporate tax rate (or introduce other measures to reduce effective tax rates), historically it has objected to the CCCTB on the basis that it might threaten or limit its sovereignty over its own tax policy. The absence of the obligation to adopt any CCCTB measures may therefore afford greater flexibility to the U.K. in adopting “positive” tax competitiveness measures.
It should be noted that a failure to implement EU measures or the implementation of further “carrot” measures may conflict with the current and proposed tax regimes adopted by the EU. If the U.K. leaves the EEA as well as the EU, several EU27 jurisdictions currently have CFC rules which distinguish between EU/EEA Member States (seeking to respect the freedom of establishment principle) and third countries (upon which much tougher conditions are imposed). Should the U.K. corporation tax rate fall below 15 percent, it could easily be lower than 40 percent of the effective tax rate of the higher rate EU27 Member States and thereby trigger the CFC rules as proposed under the ATAD, particularly if a U.K. subsidiary is relying on the patent box or claiming R&D credits or other enhanced reliefs.
Our speculation above contains a heavy caveat. The implementation (or absence of implementation) of measures to improve the U.K.’s tax competitiveness does not occur in a vacuum but rather coincides with both an EU exit negotiation process and a period during which the U.K. may seek to renegotiate the terms of many of its bilateral tax treaties to mitigate the loss of the Interest and Royalties Directive. This will not be lost on EU member states when it comes to considering both EU tax policy and their own domestic tax policy. When the reduction in the corporate tax rate was flagged by George Osborne, EU finance ministers noted that any plans to reduce corporate tax rates was “not a good way to start negotiations” and it may therefore be possible that alternate “carrot” measures will be met with resistance from the EU.
It remains to be seen the extent to which details of the U.K. Government's approach to tax policy post-Brexit will be revealed in the Autumn Statement on November 23. In the interim, it is critical that taxpayers engage with the Government on tax competitiveness to ensure that the U.K. continues its trajectory to becoming the most tax competitive jurisdiction in the G-20. There is no better time to have your say than when the government says it is in listening mode.
Tom RothTom is a Senior Associate in the London tax group. He advises local and international clients on the tax aspects of acquisitions, mergers and restructures as well as supply chain issues. Tom is a contributing author to the International Bureau of Fiscal Documentation (IBFD), Laws of Australia (Thomson Reuters) and the Law Reviews. Tom has also presented on international tax planning issues at Tax Executive Institute conferences. Mark BevingtonMark is a London based partner. He specializes in all aspects of the taxation of intangible property, most especially the relevant U.K. regimes, international structuring and hub structures. Mark advises a number of major global corporations, mainly in the media and technology sectors. Mark has acted for clients in resolving significant and difficult disputes, including disputes heard at the U.K. Tax Tribunal and the European Court of Justice.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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