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Michal Scholtz | August 11, 2016

“Brexit” and its possible tax effects

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According to the results of the June referendum, the British have voted in favour of leaving the European Union (EU), the so-called “Brexit”. There will surely be a long way, still, to a final end of this relationship with continental Europe, which lasted for many years, because to a large extent, the law in Great Britain is still influenced by many regulations, directives and decisions the EU has issued so far. All legal acts issued by the EU, which Great Britain had committed to abide by, will probably become non-binding for the Great Britain from now on. Britain will thus have legal freedom to decide, which of the provisions it will keep among its acts and which ones it will cancel.

Departure of Great Britain from the EU will surely also represent an intervention into British tax law. The EU has been trying to harmonise the tax law across all member states since its beginning already. According to the EU, tax harmonisation is fundamental for strengthening the common European market, for making the EU more attractive for investors and the workforce. Historically, harmonisation has been accentuated mainly in the realm of direct taxes (especially the corporate income tax) as well as indirect taxes (VAT, excise taxes and customs). While a relatively high degree of harmonisation has been achieved in the case of indirect taxes, in the case of direct taxes it is the contrary and this area still remains mostly within the competence of the individual member states.    

We will try to outline the possible scenario of what tax effects the departure of the Great Britain from the EU could have for the Czech Republic or Czech companies in the text below.

Direct taxes

In the realm of direct taxes, only some partial successes have been achieved so far. Mainly the adoption of the following directives has helped towards harmonisation:

  1. The directive on mergers
  2. The directive on subsidiaries and parent companies
  3. The directive on taxation of interests and royalties 

The application of these directives if the set conditions are fulfilled enables for example exempting from taxes the revenues ensuing from profit sharing, interest or royalties, between a parent company and a subsidiary, or between otherwise related entities within the European Union.

With regard to maintaining competitive ability for foreign investors, compared to the EU member states, the Great Britain can be expected to maintain the principles ensuing from the above-mentioned directives even after leaving the EU. From this perspective, it is not so important, if Great Britain becomes part of the European Economic Area, following Norway, Iceland or Liechtenstein, or if it chooses the so-called Swiss model, because even towards these countries, which are not members of the EU, exemption can be applied.

The Great Britain has concluded a countless number of bilateral double tax treaties, among other with the Czech Republic, too. The double tax treaty between the Czech Republic and the Great Britain (same as a vast majority of double tax treaties) is based on the so-called unified model of the OECD. Departure of the Great Britain from the EU should have no fundamental effect on the interpretation of these double tax treaties.

In case the situation occurs that the above-mentioned directives cease to be applied towards the Great Britain (and are not adequately replaced), the above-mentioned income would be subject to a less advantageous tax regime (the withholding tax), though, because the double tax treaty does not provide such an advantageous regime in all cases. Only the future will thus show the actual effects.

Indirect taxes

The departure of Great Britain from the European Union will also have a significant effect on the value added tax. The effects and changes, which the narrowing of the European Union will bring, can again not be clearly determined in advance, or more precisely, they can hardly be determined in advance. Because all depends on negotiations and treaties, which the Great Britain will conclude upon leaving the EU. We will outline some effects the Brexit may come, though, briefly. 

Upon its departure from the European Union, European law will cease to apply to Great Britain, that is for the area of VAT it will mainly be the important Council directive on common VAT system and the Implementing decree of the EU Council. Great Britain will be able to apply its own legislation for the realm of VAT and thus set up for example the rates of the tax, the extent of exemption or the object of VAT regardless of European legislation. In some areas, there might thus be collisions between the intra-state legislation of the Great Britain and European legislation, which may even lead to double taxation, or non-taxation (for example in case of an unsuitably established location of a transaction).

After departure from the European Union, the territory of the Great Britain, unless other conditions are negotiated, will no longer be considered “European” space and any movement of goods out of or into Great Britain should be considered export or import, respectively. Trade will thus become more demanding administratively, and it will also be possible to consider an imposition of taxes on goods (unless they are subject to other separate customs agreements), which may now have unpredictable effects on the contractual parties involved. Movement of goods to Great Britain will no longer be subject to posting in Intrastat or in a summary report.

Further changes may also occur in some cases during the provision of services, for example when establishing the location of a transaction. 

Providers of electronic services to persons not liable to taxation will also have to deal with complications. While these providers have been able to use a simplification when returning VAT from electronically provided services using the Mini One Stop Shop system since January 2015 within the EU, after departure of the Great Britain, they will have to re-examine the setup of the VAT regime.

Of the other areas the Brexit will affect, it is worth mentioning for the example the process of returning of taxes paid in the Great Britain (European law, which harmonises the return and sets up a unified process, will probably not be applicable anymore), mail-order sales or the use of simplification in the form of three-way trade.

To see what the actual situation of VAT application after Brexit will be, we will have to wait until the agreement between Great Britain and the EU, though, same as in the case of income taxes.