The draft Withdrawal Agreement: implications for taxation and customs
On 14 November 2018, the UK and the EU published the provisionally agreed text of the draft agreement setting out the terms of the UK’s withdrawal from the EU (the ‘draft agreement’). As of the day of its entry into force, on 30 March 2019 (assuming it passes through the legislative process, which is as yet unclear), the UK will no longer be an EU Member State and, but for the agreement, EU law in its entirety would cease to apply to the UK.
However, the draft agreement provides for a transition period until 31 December 2020 (or later if agreed by a committee comprising representatives of both the UK and the EU): during that time, EU law will largely continue to apply in the UK.
This means that, if the draft agreement is adopted in its current form, not much will change in terms of taxation and customs treatment on exit day. For example, throughout the transition period both the UK and EU Member States should continue to apply the Parent-Subsidiary Directive (Council Directive 2003/123/EU) and the Interest and Royalties Directive (Council Directive 2003/49/EC) to UK companies as if the UK was still an EU Member State, potentially allowing UK companies to benefit from reduced or zero UK withholding tax on payments to associated companies resident in EU Member States.
Instead, the most significant changes will come into force at the end of the transition period when the UK will no longer be governed by EU law. While it is expected that more detailed provisions about the future relationship between the UK and the EU will be agreed during transition period trade negotiations, the draft agreement sets out certain basic provisions about what the position will be after the transition. Those provisions, as they apply to taxation and customs in particular, are discussed below.
It should be noted that even though the UK and the EU agree that the UK will continue to be treated as an EU Member State during the transition period, from the perspective of third parties, the UK will in fact cease to be an EU Member State on exit day.
- This could mean that UK companies may not be able to benefit from certain provisions in double tax treaties that specifically apply to companies that are resident in EU Member States.
- An example is the derivative benefits test included in US treaties, which at present could allow UK resident subsidiaries of EU resident holding companies indirectly to benefit from a treaty between the US and the holding company’s jurisdiction and thereby benefit from lower or zero withholding tax.
Ongoing matters and continued cooperation
For a limited time after the end of the transition period, the UK will continue to have partial access to certain networks and databases operated by the EU relating to customs, excise and VAT in order to allow it to exercise its rights (if applicable) and comply with its obligations in respect of Regulation 952/2013 (the Union Customs Code – ‘UCC’), Council Directive 2006/112/EC (the ‘Principal VAT Directive’) and Council Directive 2008/118/EC (the ‘Excise Directive’).
- Exact time limits for such access varies between different networks.
- The list of networks to which the UK will continue to have access includes the Common Communication Network – which will also be used to facilitate the automatic exchange of information on reportable cross-border arrangements pursuant to Council Directive (EU) 2018/822 (‘DAC6’) – but it is not clear whether the UK’s access rights will go beyond customs, excise and VAT to also cover data collected pursuant to DAC6.
- As further discussed below, the backstop solution provides for continued cooperation between the UK and the EU to combat tax fraud and evasion in accordance with Directive 2011/16/EC (as subsequently amended by DAC6). However, if the backstop solution does not come into force it is not clear whether such cooperation will continue.
In respect of VAT, a taxable person’s rights and obligations under the Principal VAT Directive in relation to a transaction will continue to apply until five years after the end of the transition period. The position for VAT refunds and amendment of returns is worth noting:
- The rules relating to VAT refunds set out in the Principal VAT Directive and Implementing Regulation 79/2012 – whereby applications for refunds of VAT paid by UK residents in EU Member States are made by sending an electronic refund claim to HMRC – will only be available until 31 March 2021. From then on, UK businesses will be treated as non-EU businesses and will instead need to send VAT refund applications directly to the national tax authorities in the EU country where they incurred the VAT in accordance with the procedure set out in Directive 86/560/EEC.
- Amendments to VAT returns submitted in the UK pursuant to the Principal VAT Directive with regard to services supplied in an EU Member State (or vice versa) must be submitted by 31 December 2021.
Unsurprisingly, it has been agreed that key parts of EU legislation on customs and indirect taxation will continue to apply to most goods that are in transit from the UK to the EU (or vice versa) at the end of the transition period. Where transit started before the end of the transition period, the goods will be subject to the provisions of the UCC, the Principal VAT Directive and, to the extent the goods are under a duty suspension arrangement or after release for consumption, the Excise Directive. HMRC will continue to cooperate with EU Member States’ competent authorities in respect of VAT and excise legislation for four years after the end of the transition period where transactions started before the end of the transition period.
The backstop solution
The Protocol on Ireland/Northern Ireland (the ‘Protocol’) contains some of the most significant and controversial provisions of the draft agreement.
- The Protocol sets out the so-called backstop solution, which is essentially a backup plan to ensure there will not be a hard border between the Republic of Ireland and Northern Ireland even if future trade negotiations between the UK and EU fail to reach an agreement that achieves this aim before the end of the transition period.
- Most of the Protocol will only come into effect from the end of the transition period . Unless and until that happens, the backstop solution provides that from the end of the transition period a single customs territory will exist between the EU and the UK. There will not be any customs duties on imports and exports of goods produced within, or in free circulation within, that single customs territory (but note that fishery and aquaculture products are excluded from these rules). As for imports, the UK will not apply a tariff that is lower than the EU’s common customs tariff and will align itself with the EU’s rules on the origin of goods and the value of goods for customs purposes. Even so, the UK will not be invited to participate in taking decisions on amendments to the EU common customs tariff.
In addition, in order to maintain a level playing field, the UK and the EU commit themselves to a continued common rulebook in certain taxation areas:
- There is a common commitment to principles of good governance, including the OECD standards against Base Erosion and Profit Shifting (‘BEPS’) aimed at tackling tax avoidance strategies that exploit gaps and mismatches in tax rules. The UK has been one of the leading advocates of BEPS.
- The UK also commits to continue to apply certain EU-derived provisions, such as Council Directive 2011/16/EU on administrative cooperation to combat tax fraud and evasion and the EU Code of Conduct for Business Taxation which aims to curb harmful tax competition. This is consistent with longstanding UK policy.
- The provisions in the draft agreement about the settlement of disputes between the UK and the EU arising under the agreement will not apply in respect of disputes regarding the interpretation and application of the common rulebook on taxation regulation.
Northern Ireland, for its part, will be even more closely aligned with the EU. Significant EU legal instruments relating to customs and indirect taxation, including the UCC, the Principal VAT Directive and the Excise Directive, will continue to apply to Northern Ireland (but, except as provided above, not the rest of the UK) after the end of the transition period. The effect of this is that suppliers based in Northern Ireland will not be faced with any restrictions on moving goods into the EU.