Customs, VAT and income tax are all dealt with relatively painlessly within the EU but for UK-based companies doing business in Europe, they could become a real headache. The challenge lies not only in a heavier tax burden, but also in the complication of day-to-day business. This is part one of our Brexit series.
At this stage, the final terms of Brexit are only known to those with a crystal ball. But one thing seems clear: The European Union wants Britain to feel the impact of leaving the club – and the UK itself has set course for a hard Brexit. Our analysis of possible tax implications will therefore be based on the worst-case scenario: the UK assuming a third-country status without direct links to the EU.
These are the additional burdens that UK-based international companies will need to cope with:
Until now, the principle of the free movement of goods has applied between the UK and the rest of the EU. When the UK leaves the union, customs duties may be levied on goods. "Additional costs from customs duties for buyers and sellers are not the only issue this will cause," explains Tobias Kiehl, a tax advisor at Clostermann & Jasper Partnerschaft mbB in Bremen, an internationally oriented audit and tax consultancy firm. "A lot of additional effort will be required. Companies will need to deal with customs clearance and will need to train their staff and adjust their computer systems. In addition, timelines for processing and shipping will need to be recalculated from scratch." Some companies might be forced to set up customs warehouses in other countries to ensure that they can deliver goods to their customers on schedule. The temporary storage and associated administration will put a notable dent in the companies' profits.
Within the EU, a joint VAT directive is applied. This directive sets out the rules for the imposition of value added tax among EU member states. In practical terms, this means that whenever VAT is applicable in cross-border transactions between EU countries, the tax treatment is uniform across the EU and results in a neutral tax liability. When it leaves the EU, the UK will be able to completely overhaul its VAT legislation, as the country will no longer be bound by the rules of the European VAT directive. But even if the current UK VAT rules remain in place, there will be negative consequences. VAT and the deduction of input tax are systematically coordinated and aligned for all EU-internal matters – but not for scenarios involving third countries. This poses significant risks to companies, because liquid funds could get tied up for prolonged periods of time. In addition, all affected parties face substantial legal uncertainty while the legal framework of the new UK–EU relationship remains unclear, which could greatly hinder day-to-day business.
The EU has also established successful mechanisms to prevent multiple taxation with regard to income tax, such as the Parent-Subsidiary Directive. This establishes, for instance, that a subsidiary can generally distribute profits to its parent company without any tax being withheld at source. This rule may no longer apply in future. Until new rules are in place, the applicable legal basis would be the existing double taxation treaty between Germany and the UK, which stipulates a 5 per cent rate of withholding tax.
As a rule, companies within the EU can reorganise their corporate structure as they wish, without concerns about possible negative tax implications. One of the key frameworks in this context is the EU Merger Directive. However, this might change after Brexit. Once this directive no longer applies, restructuring measures such as a relocation of a company's registered office, a change of parent company or subsidiaries or a change of legal form would lead to immediate negative tax consequences without any corresponding inflow of liquidity. This is because in these types of cross-border transaction with non-EU countries, companies are forced to utilise their hidden reserves (gains on capital invested, for example, in properties or long-term equity investments), because the governments involved would immediately charge tax on the hidden reserves that fall into their respective jurisdiction.
Tariffs, VAT and income tax, modification of corporate structures – these factors inflict a financial burden on companies, but not only in the form of new taxes and levies, but also through new and labour-intensive processes. "Companies will have to adjust their computer systems and will constantly need to consider two legal systems – German law and UK law," explains tax advisor Tobias Kiehl. "This means they will be slower, less flexible and subject to greater constraints." On top of this, there will be a lengthy period of uncertainty until all agreements have been negotiated. This could take many years.
Instead of waiting and hoping for the best, you should act now. Here are some practical tips:
What market do I want to sell in? Who do I want to target? Where are my customers based? Once you know your current and future target group, you can make a well-founded decision about where your company should be based in future. If you require access to the European market, setting up on the continent will be your safest option.
Will the current company structure still be suitable if customs duties and VAT are levied or handled in a different way? Might it be necessary to relocate production?
Where are your employees from? Will they remain available to you in future or are they affected by the loss of free movement and tied to continental Europe? Companies need to review the applicable labour law and analyse the labour market.
Will I still be able to repatriate profits without problems? New tax withholding rules could cut your profits significantly. Companies should prepare for this at an early stage.
If any of the above issues seem relevant to your company, it may be time to start seriously considering a change of location. You will probably have questions around taxation, setting up business and corporate structures, and there are many options to consider and choices to be made. We can support you on this journey and can put you in touch with competent professionals from different fields to discuss all of your questions.
As a location, Bremen offers everything you could wish for: a central position in Europe, with close links to the sea and other waterways, nearby airports that provide connections to all major European transport hubs and strong local infrastructure that makes it easy to get around. And on top of all this, highly-trained staff and internationally-oriented partners are ready to tackle your challenges with you.
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