While it is likely that the UK would keep under domestic law a value added tax, cross-border trade would be complicated, with implications on Financial Services organisations facing VAT costs. The VAT position for British banks operating in Europe may become similar in complexity to the considerations already faced by US banks in choosing which operations to run through London branches and which from New York.
Withholding tax exemption for interest payable to British banks and companies from borrowers on the continent, under the EU Interest and Royalties Directive, will cease. This will affect even existing lending facilities. On the UK lender side, bilateral double tax treaties (where existing) will need to be reviewed, making treaty claims to reduce withholding tax at source where possible. Interest paid by UK borrowers to continental European non-bank lenders will also be subject to the UK withholding tax at 20%, again unless a bilateral tax treaty provision can be invoked.
In the medium term, corporation tax policy is likely to shift as the constraints on the UK’s taxing powers due to the EU freedom of capital movement rules are lifted. Corporate structures involving holding companies in EU countries with lower effective rates for certain forms of income, such as the Netherlands, Luxembourg or Ireland, may face additional UK measures which are not currently permissible under EU law. Current direction of policy (outside of banks and building societies and the oil and gas sector) is to lower and simpler rates of tax on corporate income, but this does not preclude a widening of the tax net, allowed following Brexit, even assuming no change in government.
Are there downside risks?
While a move to exchange controls looks immediately unlikely, even with the loss of AAA credit rating the UK remains a major economy with its own currency and therefore able in principle to service all obligations (with only inflation forming a constraint). However in the event of further economic shock combined with regulatory-generated capital outflows to the Eurozone it should not be ruled out in contingency planning by FS clients. Although it would be described as a temporary measure, capital controls tend to persist – for example Iceland retains controls over £2bn of offshore investment as well as local pension funds 8 years following its crisis.
What would exchange controls look like for the UK:
- There would be limits on personal electronic transactions via UK and Crown Dependency bank accounts and credit cards, with merchants outside the sterling zone.
- Corporates requiring imports and unable to settle through overseas receipts would require Bank of England permission for acquisition of FOREX.
- Existing Euro and US$ denominated debt settling in London will create a UK source of FOREX likely available to UK corporates at a premium through a Bank of England auction.
- UK / Jersey / Guernsey investment funds and UK defined benefit pension funds will lose flexibility to switch between UK assets and non-UK.
- UK headquartered banks would need to provision separately for capital for their UK operations and international branches. To some extent this planning is already in progress with the 'ringfencing' of domestic commercial banking from investment banking and overseas operations.
As advance announcement of any imposition of exchange control would produce a rush for the exit, the likelihood would be implementation at no notice over a weekend, possibly with extension.
Are there positives?
From a tax policy perspective, regardless of the politically chosen tax rates, it is generally seen as advantageous for all taxpayers with economically similar operation to be taxed similarly. EU membership, and in particular the extension of the “freedom of corporate establishment” to tax legislation has had unintended consequences for purely domestic companies which are unable for reasons of scale or geographic location to shift operations and revenue into the lowest taxed EU jurisdictions. These rules would likely be removed on any form of exit, putting UK-only and multinational groups on more of a level playing field.
Assuming the UK 'eurobond' tax exemption is retained (which allows companies of any description to finance in any currency through listed bond issues in London without withholding tax applying) there would be the potential for 'offshore financing' of € denominated securities to be centred in London in the same manner as the $ market already is. It is difficult to see how the ECB could prevent voluntary clearing of € financing through UK based banks and UK branches of foreign banks, even where 'official' clearing facilities are moved to the Eurozone.This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.