Brexit and “direct” taxes

The most important EU directives to support the “freedom of establishment” 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. The UK acts as an International Holding Company (IHC) location and an important foreign direct investment gateway into the EU.  Under Brexit and absent the UK’s entitlement to these Directives, EU subsidiaries would not 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, but not as comprehensively as under the EC Directives.

On the flip side, a significant amount of foreign direct investment into the UK also comes from the EU. The UK does not impose dividend withholding taxes. It does impose interest and royalty withholding taxes, although generally treaties with EU member states reduce the withholding to manageable rates.  However, zero withholding rates cannot be guaranteed under all bilateral treaties so the UK’s continued participation in the EC Directives is something to be certainly desired.

The European Commission (EC) has been active in challenging the concerned Member States where their practices are perceived to be 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, but otherwise not.  At some point after Brexit the UK could reintroduce domestic law that previously has been held to be contrary to EU law. On the opposite hand, EU Member States might apply anti-avoidance rules to arrangements with UK businesses that previously would have been exempted. This may happen automatically where the exemption is limited to EU countries and UK businesses would be immediately affected by virtue of Brexit.

The EC is pushing hard for full harmonisation of corporate income taxes by introducing the CCCTB of which the UK has been an opponent.  Brexit might mean faster progress for the rest of the EU regarding future harmonisation of corporate income taxes. For the UK, it would mean the retention of sovereignty over fiscal matters and perhaps cutting corporate income taxes to attract inward investment.  As not all member states necessarily support full harmonisation of corporate income taxes the jury is out on the EU’s future direction of travel in this matter in the absence of the UK playing a vital role.

UK IHC structures will need to be reviewed in the light of loss of participation in the Parent-Subsidiary or Interest and Royalty Directives.  Absence of “state-aid” concerns might encourage international businesses, particularly US companies, to look favourable on using the UK as their regional “hub” rather than Ireland or Luxembourg.  Possible further lowering of corporate income tax rates might further encourage overseas MNCs to explore the possibility of using the UK as an IHC, particularly if the loss of EU Directives can be counter-balanced by negotiating equivalent bi-lateral agreements with EU member states.