The EU is a customs union as well as a single market. As a customs union, there are no customs duties within the EU’s territory, and Member States share common external tariffs with third countries.
As a single market, The EU shares a VAT system that is harmonised and charged on a consistent and integrated basis across the whole of its territory.
In recent years the Court of Justice of the European Union (CJEU) and an increasingly proactive Commission have significantly restricted Member States’ freedom within the tax area through proceedings for state aid, for discrimination and for restrictions of the fundamental freedoms. Therefore, while corporate income taxes may not be harmonised in the way that VAT and customs duties are, membership of the EU has nevertheless had a fundamental effect on parts of the UK’s tax code, such as the controlled foreign companies, transfer pricing and corporate distribution rules.
Over the past 15 years, the Commission has become more and more active in pushing its agenda for further integration. This has culminated in the call for a “Common Consolidated Corporate Tax Base” (or CCCTB): a single set of rules applied consistently across the EU. While Member States would be able to choose the tax rate that suits them, the rules for computing taxable profits would be set at the level of the EU: a single corporate income tax system to match the single VAT system. Not all Member States support this, especially Ireland which uses it's 12.5% rate of corporation tax as a competitive advantage. One of the most vocal opponents of CCCTB has been the UK. Recognition amongst Member States of the need for co-operation in the international tax arena to eliminate tax planning by multinational groups and Brexit means that CCCTB is now more likely than at any time previously.
On leaving the EU, the UK will cease to be a part of the customs union. While there is precedent for a third country to be a part of the EU’s customs union (Turkey), this seems particularly unlikely here.
The UK and the EU may enter into a free trade agreement with no or very low customs duties (whether because the UK joins the EEA, or more likely through bilateral agreement). This will be important for UK and Ireland trade.
Value added tax
The EU is about free trade, and multiple different sales taxes across the EU would have distorted competition within the single market and inhibited that free trade. VAT has therefore been harmonised within the EU since 1977. Following Brexit, the UK would sit outside of the territorial scope of EU VAT.
It would therefore be open to the UK to change how VAT is charged in the UK, or even to replace it with an entirely different tax. Significant change in particular to the architecture of the VAT system in the short term seems unlikely. The cost to Irish companies operating in the UK of adopting new VAT procedures would be significant if such were to arise.
Over time some divergence is likely, although the risk of double taxation or double non-taxation may well incentivise the UK to keep its VAT system materially aligned with the EU’s. The most tangible consequence of Brexit would likely be the imposition of “import” VAT when goods enter the EU from the UK, and when EU goods enter the UK. The VAT would often be recoverable – but Irish businesses must consider the unwelcome cashflow implications.
To date the EU has implemented a number of harmonising Directives intended to support the freedom of establishment. The most important are the Parent-Subsidiary Directive and the Interest and Royalty Directive, which prohibit withholding taxes on intra-group interest, dividend and royalty payments made within the EU.
Half of all EU headquarters of third party multinationals are based in the UK. The main EU recipients of investment from the UK are the Netherlands, Luxembourg, France, Ireland, Germany, Sweden, Spain, Belgium and Italy. EU subsidiaries would not be able to rely on these Directives to be able to pay dividends or interest to their UK holding companies free from withholding taxes. Relief under bilateral double tax treaties would be an alternative, and in many cases would also eliminate withholding taxes entirely. However, not all treaties provide for a 0% withholding tax.
For example, problems may persist in relation to dividends paid by German or Italian subsidiaries who may now consider relocating their headquarters to Ireland. Whilst the UK does not impose dividend withholding taxes, it does impose interest and royalty withholding taxes. Generally treaties with EU member states reduce the withholding rates to 0%. Again, this is not always the case. For example, the treaty rate for withholding taxes on royalties paid to Luxembourg is 5%.
CJEU case law and State Aid proceedings
The Commission has been active in challenging the domestic tax laws of Member States before the CJEU on the basis that they are discriminatory, contravene one or more of the fundamental freedoms or constitute state aid. If the UK were to join the EEA then it would continue to be subject to these restrictions. Otherwise, it would not.
A good example of such a challenge is the decision that EU controlled foreign company rules (that is, rules which tax a parent directly on the profits earned by a subsidiary established in a low or no tax jurisdiction) cannot apply to subsidiaries established in another EU Member State unless the arrangements are “wholly artificial”.
At some point after Brexit we may see the UK reintroduce UK tax rules that have been held to be contrary to EU law.
Tax-related state aid investigations are becoming more high profile. The United Kingdom would have more scope to adopt competitive tax regimes that have been found to be or would be contrary to state aid rules giving it a competitive advantage.
The future of corporate income tax within the EU
The EU is at a crossroads now in terms of where it will go with corporate income taxes. The Commission is pushing hard for full harmonisation by introducing the CCCTB.
Adoption of the CCCTB across the whole EU requires unanimous consent. It is difficult to know how much real support for the CCCTB there is among Member States, but Ireland and the UK have been vocal opponents. Even if we do not see a CCCTB, further integration still reflects the direction of travel.
In June 2015 the Commission proposed an Action Plan for “A Fair and Efficient Corporate Tax System in the European Union”, and in January of this year published a draft “Anti-Avoidance Directive”. Both of these proposals are intended to harmonise the EU’s corporate income tax systems to some extent. We would not be surprised if the most significant impact of a Brexit, both for the UK and for the EU, would be in respect of the future harmonisation of corporate income taxes.
For the UK, it would mean the retention of sovereignty over fiscal matters. For the rest of the EU, there is the possibility that a Brexit could accelerate the harmonisation of corporate income taxes. This will not necessarily be the case; but the loss of a large and influential Member State that is opposed to it could be decisive.
What does this mean for you
We have already assisted a number of companies located in the EU (particularly in Italy and Germany) that had intended to establish operations in the UK. These companies are concerned about how the loss of the benefits of the Parent-Subsidiary Directive and Interest and Royalty Directive will affect group structures.
If you would like to know more please do not hesitate to contact us.