How will the result of the EU referendum affect the UK’s tax system?
In the short term, the answer is ‘not at all’. For the moment, and probably for most of the next two years, the UK will continue as a member state of the EU, and EU rules will continue to have effect in the same way as at present.
In the longer term, however, there may be significant tax changes, in addition to the alterations in customs duties on trade with the EU and third countries that are implicit in leaving the single market, and which have been debated at length during the referendum campaign.
The EU has an impact on UK tax rules in, broadly, four different ways.
Common EU rules
First, there are certain areas, such as VAT, where common EU-wide rules apply. In broad terms, if the UK wishes to introduce a new VAT exemption, or change the rules as to the place where cross-border supplies of goods and services are treated as made for VAT purposes, it cannot do so. Once it has left the EU it will be free to do as it pleases.
That does not mean, however, that VAT will automatically disappear unless Parliament chooses to reintroduce it. The relevant EU rules take the form of 'directives' rather than directly applicable 'regulations'. This means that they have had to be implemented by means of UK legislation rather than applying automatically. Once the underlying directives are no longer applicable because the UK is no longer within the EU, the UK legislation will remain and will continue to apply unless or until the government chooses to amend, replace or repeal it.
In practice there appears to be little realistic prospect of VAT being repealed, as it is a major source of revenue for the Treasury. In addition, VAT is by no means solely an EU tax; an increasing number of countries in all parts of the world have introduced VAT (or a broadly equivalent goods and services tax) in recent years. More significant is the freedom that leaving the EU will give the Government to introduce different VAT rates for different purposes (including rates above or below the current EU maximum and minimum) and to exempt or zero-rate further items.
A further area where common rules apply is the EU’s parent-subsidiary directive, under which dividends from a company in one member state to certain related companies in another member state must be paid free of any withholding tax. Once the UK is no longer in the EU, the directive will not apply, and dividends received from other member states may be subject to withholding tax, depending on the terms of the double tax treaty between the UK and the state concerned.
State aid
The second area where EU rules affect UK tax relates to state aid, where subsidies to a particular industry from the government of a member state are prohibited without the permission of the Commission. The Commission takes the view that making a tax relief available to a particular industry is the equivalent of subsidising it from public funds. The result is that many UK tax reliefs are announced by the Government ‘subject to approval from the European Commission’. Others, presumably, are never announced at all, because the Government knows that approval will not be forthcoming. In future the UK will be able to give whatever tax reliefs it wishes. Some of the reliefs currently affected by these rules are those for the Enterprise Investment Scheme, Venture Capital Trusts, research and development expenditure, the ‘patent box’ and the tonnage tax system for shipping companies.
Freedom of establishment and free movement of capital
The third area relates to the four ‘fundamental freedoms’ enshrined in the EU treaty, particularly ‘freedom of establishment’ and the ‘free movement of capital’. The European Court of Justice has been active in enforcing changes to members states’ tax rules based on these freedoms, either in cases brought against states by the Commission or in interpreting national rules in disputes between tax authorities and taxpayers. In broad terms the requirement is that the law of a member state should not treat its own nationals or enterprises more favourably than those of other member states. Perhaps the most notable example, for the UK, was a decision of the court that the UK must give corporation tax relief to a UK company for certain losses incurred by subsidiaries established in other EU member states.
No doubt the UK will eventually wish to change its rules in some of these cases, where it will no longer have any obligation or inclination to favour enterprises of EU states over those established elsewhere in the world, or to grant UK tax reliefs that were never intended to apply in a cross-border context. Nevertheless, few of these are areas where urgent action may be expected.
EU plans for the future
Fourthly, there are areas where the UK tax system would have been affected in the course of time by the move to ‘ever closer union’; for example, the proposal for a ‘common consolidated corporate tax base’, under which companies’ taxable profits would have been calculated in a uniform way across the EU. Clearly, such proposals will have no further impact on the UK.
Conclusion
The ‘exit’ decision will have no immediate impact on the UK tax system. Even when the formalities of withdrawal from the EU are completed, this will not be the signal for immediate major changes. Rather, the UK’s new status will give the tax system the freedom to develop over time, for good or ill, without some of the constraints that currently apply to it.