Implications for the UK tax system of an EU exit

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In less than 18 months’ time, the UK will hold a referendum on whether to stay in the EU or leave. With waning confidence in polls, nothing is certain. If the decision is to leave, what could that mean for the UK tax system?

The most immediate issue is the future of VAT – a tax which was introduced as a direct consequence of this country joining the European Economic Community, the predecessor to the European Union.

While it is almost certain that VAT or something very similar to it will be retained, the basis of VAT is to be found in EU directives and, following a UK exit, these would no longer be binding. The UK would be free to decide that the tax applied to different types of goods and services than at present and rates could be set differently.

The final interpretation of VAT law currently lies with the European Court of Justice (ECJ) and it is not clear whether their future or even their past decisions would be treated by the UK courts as continuing to be binding. In the Halifax case, the ECJ applied the concept of abuse of law to strike down VAT avoidance arrangements and UK courts have followed this. Would they be able to continue to do so? Similarly, in recent years, the UK courts have shown a tendency to bypass the UK legislation and refer directly to the text of the directive. So in the BAA case, the Court of Appeal determined that commissions paid to BAA for promoting a credit card were exempt by first construing the terms of the exemption in the directive. The Judge suggested that it would have been better if the UK legislation had simply replicated the terms of the directive. But if the directive is no longer binding, what status do these court decisions have?

Although UK direct tax law – income tax, capital gains tax, corporation tax – is still the responsibility of the UK Parliament, over the last decade it has had to be modified in major areas to make it compatible with EU anti-discrimination laws.

The transfer pricing regime originally had a UK to UK exemption – reflecting the essentially cross-border nature of the abuse being targeted – but this exemption was removed following the decision in Lankhorst-Hohorst. In the Marks & Spencer case, the UK was forced to extend group relief – which allows for the offsetting of losses among a group of companies – to foreign subsidiaries. The ‘controlled foreign companies’ rules – targeting the diversion of profits to low-tax jurisdictions – had to be comprehensively rewritten after being challenged in the Cadbury Schweppes case. The difference in treatment of dividends received from UK and foreign subsidiaries did not stand scrutiny in Franked Investment Income (FII) GLO.

If this anti-discrimination law no longer applied, future challenges along these lines to the UK tax system would not be possible. The UK government might even start to revisit its past responses to these challenges.

The 1.5 % stamp duty reserve tax  ‘entry charge’ on the issue of shares into a depositary receipt systems and clearance services no longer applies because it was held to breach the EU Capital Duties Directive. If the UK left the EU, it could then reimpose capital duty on the issue of shares or securities.

UK tax reliefs, including the Enterprise Investment Scheme, Venture Capital Trusts, Enterprise Management Incentives, have had to be tailored not to breach the EU rules on unlawful State Aid. If these rules no longer applied, the UK government would be free to extend and increase these reliefs.

At Walker Morris, we will be keenly watching this space to ensure our clients have the clearest idea of what the UK tax system would look like in the aftermath of a UK exit.