Brexit and company taxes: What happens from Jan.1, 2021?

ARTICLE | January 14, 2021

Authored by RSM US LLP

As of Jan. 1, 2021, the UK is officially no longer a member of the EU, and the transition period included with the Withdrawal Agreement between the EU and the UK comes to an end.  Now that Brexit is officially here, companies should implement plans to cope with the tax changes that it may bring, and also keep in mind that more developments will likely emerge in the near future.

The UK left the EU on Jan. 31, 2020 and was in a transition period during which the UK must abide by its undertakings as a member of the EU, and the EU members must afford the UK the benefits of membership. The UK incorporated EU legislation into domestic law so that as of its departure, the UK technically remains aligned. However, the process of transposing thousands of regulations into UK law was messy and tracking down legacy EU provisions in the UK statute has been tricky.

EU tax directives were incorporated into UK law from the outset and Brexit required very few changes. But that does not mean that Brexit will have no impact. On Dec. 31, 2020, the end of the transition period, the EU Directives ceased to apply. Dividends paid up from EU-27 subsidiaries (those remaining in the EU after Brexit) may suffer withholdings.  UK law does not impose withholding tax on dividends paid, and interest and royalties in either direction may suffer withholdings albeit reduced by most bilateral double tax treaties (the relevant EU directive never applied to payments between indirectly related entities). Treaty rates may be reduced further by a more beneficial rate in a different treaty signed by one of the states if the UK has “most favored nation status”[1]. Existing withholding tax certificates may need to be refreshed to reflect the future entitlement to claim.  Of course, Brexit has significant VAT implications.  See also ‘Brexit is finally happening: What VAT actions to take before Dec 31?'

Similarly, international treaties sometimes define “good list” jurisdictions, which may benefit from a favorable treatment, whereas entities in other territories may be subject to more detailed qualifying tests. Take for example the Limitation of Benefits article in the U.S.-UK double tax agreement, which has a number of tests for when a taxpayer is excluded from treaty benefits. The concept of equivalent beneficiaries is used to define when there are benign interactions with third countries, i.e. arrangements that are not taken to be treaty shopping or a potential abuse that would preclude treaty benefits. An equivalent beneficiary must be a resident of a Member State of the European Community or of a European Economic Area (EEA) state or of a party to the United States Mexico Canada Agreement. Post Brexit the UK may continue to recognize an equivalent beneficiary in the EU-27, but in similar circumstances, an EU-27 state would no longer recognize the UK as part of the EU or potentially as part of the EEA. It will be necessary to obtain the agreement of the competent (fiscal) authority of the other contacting state in order to qualify for treaty benefits where it cannot be demonstrated that there is no limitation of benefits. Alternatively, steps could be taken to secure treaty benefits though satisfying one of the other tests in the limitation of benefits article.

While the UK and the EU-27 have agreed to behave as if the UK has the benefits of EU membership during the transition period, this agreement is not binding on third countries.  For example, under the U.S.-Switzerland double tax agreement Limitation of Benefits provision, it is permissible for 70% of a company’s share capital to be beneficially owned by residents of EU Member States with which the United States also has a treaty. There is nothing that binds Switzerland to affording the UK the benefits of EU membership throughout the transition period. Therefore, from Feb. 1, 2020, taxpayers may need to confirm entitlement to treaty benefits by initiating a mutual agreement process between the competent authorities of the treaty states.

With the adoption of either the principal purposes test or the Limitation of Benefits provision mandated by the Multilateral Convention (which updates double tax treaties for agreed measures coming out of BEPS), along with other provisions within the convention which also prompt a mutual agreement process, it is expected that applications to competent authorities for clearances will increase significantly. The BEPS papers talked about the need for mutual agreement procedures to be faster and more efficient, which can only be determined over time, but for other reasons performance levels in 2020 are not necessarily a reliable benchmark.  

The talks may yet lead to a post-Brexit trading agreement between the EU-27 and the UK. Whether these tax treaty issues would be addressed is perhaps doubtful, but even if they are, the legislative process may still leave us with a period of uncertainty.

Considerations for U.S. multinationals

A U.S. multinational with UK subsidiaries in its structure, particularly a structure including a UK holding company, should review the anticipated transactions between the UK subsidiary and other affiliated EU entities to determine the impact these changes may have on the multinational’s global effective tax rate.  For example, a U.S. multinational’s UK corporation may not have established a deferred tax liability (DTL) for repatriated earnings in a EU-27 subsidiary due to the incorporation of an EU directive eliminating withholding tax into UK law.  Now, if material, the UK corporation may need to create a DTL to reflect now-applicable foreign withholding taxes.  This could potentially negatively impact the U.S. multinational’s global effective tax rate.

If after a review of the structure and anticipated transactions, it is determined these legislative changes have a significant negative tax and/or financial statement impact, taxpayers should consider structural changes to improve adverse financial impacts arising from Brexit.

[1] Under the WTO agreements, countries cannot normally discriminate between their trading partners. This principle is known as most-favored-nation (MFN) treatment.