The Brexit deal and tax – what did we end up with?

Over the festive period a Brexit deal was finally agreed between the UK and the EU, just in time for the end of the transition period on New Year's Eve.

This blog looks at the key tax provisions in the EU-UK Trade and Cooperation Agreement (TCA). It also takes a broader look at some of the main UK tax implications of Brexit.

The TCA was agreed on 24th December 2020 and means that the UK exited the post-Brexit transition period on 31st December 2020 with a 'deal'. This is the deal that will shape the trading relationship between the UK and its former EU partners with effect from 1 January 2021.

The TCA is in force "provisionally" from 1 January, pending full ratification by the EU. In the UK, the TCA has been given effect by the European Union (Future Relationship) Act 2020, which received Royal Assent on 30 December 2020.

Before looking at the tax provisions within the TCA – a quick recap as to how we got to this point:

• The UK ceased to be an EU Member State on 31 January 2020
• During the remainder of 2020, up to 31 December 2020, EU law continued to apply in the UK and the UK remained part of the EU Single Market and Customs Union
• From 11pm on 31 December 2020, the transition period ended. EU law no longer applies to the UK

TCA – key tax provisions

The TCA itself does not contain a great deal of tax-related provisions, but the following are worth highlighting.

Trade and customs duties

The TCA provides, generally, for zero tariffs, customs duties and quotas on exports and imports of goods between the UK and the EU. There are however detailed 'rules of origin' requirements so that – in order to be eligible for free trade treatment – the goods must not originate in third countries.

Social security

The TCA also provides for the continuation of reciprocal social security arrangements between the UK and the EU. The agreement ensures that only one set of national social security rules (in the UK, the national insurance contributions regime) applies to an employee and their employer during periods when the employee might be performing duties outside of his or her 'home' state. The basic rule will remain that social security contributions will be required in the country in which the work is undertaken.

In addition, the agreement also sets out the circumstances in which the UK and EU member states will take into account relevant contributions paid into each other’s social security systems when determining individuals' entitlement to pensions and other benefits.

Tax level playing field

Tax is just one of the areas in which, pursuant to the TCA, the UK and EU have committed not to seek a competitive edge over the other (a so-called 'level playing field'). This is aimed at countering "harmful" business tax regimes that may affect the location of business activities ie by imposing a significantly lower effective level of tax than those that generally apply in the UK or the EU.

Avoidance, fraud and commitment to OECD's BEPS project

There are provisions within the TCA to enable HMRC and their counterparts in EU member states to cooperate and exchange information relating to VAT and customs fraud.

The UK and EU have also in the TCA affirmed their commitment to implementing the OECD's minimum standards against base erosion profit shifting (BEPS). This is an important aspect of the deal, as the EU's tax rules in this area often go beyond what is required under OECD guidelines.

DAC6

One very early (and largely unexpected) development linked to the agreement of the TCA was the UK's decision, effective from 31 December 2020, to depart from the EU's mandatory disclosure rules for certain cross-border arrangements (known as DAC6). These rules are designed to facilitate the reporting and sharing between EU tax authorities of instances of tax planning.

As a result of the UK's decision, the effect of DAC6 in the UK has been significantly reduced. Effectively, DAC6 in the UK now only applies in respect of 'Hallmark D', which concerns automatic exchange of information and beneficial ownership, and (broadly) covers arrangements that involve attempts to conceal income or assets, or to obscure beneficial ownership.

The UK has been able to do this as the TCA requires the UK to implement OECD tax standards (not EU ones). The UK intends to consult on, and implement, the OECD's mandatory disclosure rules (MDR). In other words, the UK is moving from the EU's rules on tax transparency (under DAC6) to the OECD's international rules (MDR). This suggests how the UK might diverge from EU rules, post-Brexit.

Other Brexit tax implications

Looking beyond the TCA, here are some of the main areas where the UK tax regime has been affected by the end of the transition period.

Indirect taxes

VAT and customs and excise duties in the UK have been based on EU law.

During the Brexit transition period, the UK continued to be treated for most purposes as if it were still an EU member state, and the UK continued to apply existing VAT rules.

Now that the transition period has ended, the UK government could (in theory) abolish VAT in the UK. Not surprisingly – given the significant revenue raised by VAT – the government has committed to retaining the tax. However the UK now has full flexibility to change the rates of VAT, to tinker with VAT exemptions, and generally to modify the VAT regime however it sees fit.

As the UK is now a 'third country' for EU VAT purposes, cross-border transactions involving the UK and EU member states will need to be looked at closely. VAT charges and requirements to register for VAT in EU member states may arise where previously, they would not.

On a positive note, it has been confirmed in HMRC guidance that input VAT incurred on costs linked to certain supplies of insurance and financial services can be recovered where such supplies are made to persons in the EU.

Direct taxes

Unlike VAT, direct taxes fall outside the competence of the EU. That said, during the UK's membership of the EU a number of UK tax rules were considered to be incompatible with EU law (in particular, the EU's "fundamental freedoms"), and were therefore amended.

One such example of a change to UK tax law, required in order to comply with the EU freedom of movement of capital, was the abolition of the UK's 1.5% stamp duties charge in respect of clearance services and depositaries. The UK government has confirmed it has no plans to reintroduce these higher rate stamp duties charges, now that the transition period has ended.

Only a relatively small number of direct tax EU Directives exist. Arguably the main EU Directives worth noting here, which have now ceased to apply in the UK, concern domestic withholding taxes:

• Interest and Royalties Directive (IRD): under the IRD, interest and royalty payments between "associated" companies in different EU member states are exempted from withholding tax (source state taxation). From 1 January 2021, some EU countries may start to deduct tax from interest and royalty payments made into the UK. UK recipients of interest and royalty payments from EU companies should check the terms of the double tax treaty between the UK and the relevant EU member state, to see how much tax (if any) will be deducted from the payment. For interest/royalty payments from UK companies to EU companies, under current UK law, the effect of the IRD should be maintained (so no UK withholdings should be required).

   

• Parent-Subsidiary Directive (PSD): under the PSD, withholding tax is prohibited on dividends paid by an EU member state company (subsidiary) to an "associated" company in another EU member state (parent). Again, from 1 January 2021, some EU countries may start to deduct tax from dividend payments made into the UK. UK recipients of dividend payments from EU companies should again check the terms of the double tax treaty between the UK and the relevant EU member state, to see how much tax (if any) will be deducted from the payment. For dividend payments from UK companies to EU companies, as the UK does not impose withholding taxes on dividend payments, the loss of the benefits of the PSD should have no impact.

The fact the UK has an extensive double tax treaty network should alleviate some of these issues for payments out of the EU and into the UK, but it should be noted that not all treaties entirely eliminate withholding taxes on interest, royalty and dividend payments (and there is an associated administrative burden in claiming treaty relief).