The UK fiscal environment for international business following Brexit

Following the UK’s spending review statement of 25 November, there is now greater clarity on how the UK economy will be taken forward into 2021 following the Covid-19 pandemic and exit from Brexit transition. 

Despite incurring record UK government borrowing this year of around £395bn, the significant further borrowing to fund investment during the recovery and in UK infrastructure previously forecast has broadly been retained.  While there may be some fiscal policy decisions made to deal with disparities and complications with the current tax system, a radical overhaul of the tax system at this stage looks unlikely and a low interest rate environment may also assist.

We examine below how the UK tax environment is responding to Covid-19 and Brexit demands, and potential impacts on the attractiveness of the UK as an international business location.

Recently proposed changes announced through consultation responses, draft Finance Bill 2020/21 legislation and other initiatives, illustrate how the government is listening to representations made by businesses.  In summary, the UK should continue to be a very attractive jurisdiction for international business even after 1 January 2021.

Hybrid and other mismatches – why is this good for the UK?

The UK was the first jurisdiction to implement Base Erosion and Profit Shifting (BEPS) action 2 rules to deal with hybrid and other mismatches, introducing them from 1 January 2017.  Despite subsequent modifications to the rules, they can operate unfairly in several instances, particularly where US ‘check the box’ entities are involved.  Changes proposed to the Finance Bill 2020/21, however, could remove many of these difficulties by widening the definition of ‘dual inclusion income’ against which excessive deductions can be offset before restrictions on tax deductions apply.

While this does not solve all the difficulties, it results in a significant widening of the definition of dual inclusion income, so should reduce unfair restrictions on tax deductions of hybrid arrangements.

There are a number of other improvements to the regime, some of which will be retrospective, others talking effect from the date of Royal Assent of Finance Bill 2020/21.

VAT on financial services

Currently when UK financial services businesses sell specified VAT exempt financial services within the EU, there is no right of recovery of input VAT on the associated costs.  However, if the sale is made to a non-EU jurisdiction there is a right of recovery for input tax on costs associated with that sale.  From 1 January 2021, however, the UK Government will extend the right of recovery of input VAT on costs of making specified financial service sales to the EU.  This will be helpful for UK-based financial services businesses and is estimated to cost the UK Exchequer around £1bn annually.  Of course, financial services businesses will need to prepare (if they have not already) for a potential hard Brexit, and  more detail on this can be found in our summary of a recent FCA Brexit webinar.

Notifications on uncertain tax positions

Several major economies, such as Australia and the US have tax rules requiring larger businesses to notify the revenue authority of uncertain tax positions taken.  The UK is considering following suite to help reduce the ‘tax gap’.  There had been concern that the definition of ‘uncertain’ for UK purposes would be based on whether HMRC would enquire into a position, which could be an almost impossible judgement for a UK taxpayer to make.  The US definition of uncertain is based on a recognised accounting definition, and the Australian uses a taxpayer assessment of whether a tax position is 50% or less likely to be correct.

The UK Government has confirmed that further time will be taken to refine this proposal, potentially leading to a more workable proposal from April 2022.

Double tax agreements

Much has been said regarding the withdrawal of access to EU Directives for UK businesses at the end of the transition period.  EU Directives such as the parent/subsidiary and interest and royalties directives can, at present, eliminate withholding taxes on payments between group companies where one is within the UK and one within a different EU jurisdiction. 

In its double tax treaty programme, the UK Government has committed to work towards replicating the benefits of those Directives in treaties with individual European jurisdictions. 

Notwithstanding this, the UK has an extensive network of double tax agreements which, in many cases, can result in more favourable treatment for related party transactions with a non-EU jurisdiction than most other EU jurisdictions.

Tariffs and customs disruption

Businesses that move goods between the UK and the EU will need to get used to accounting for duty on the movement of goods at the point of crossing the border.  If not already considered, this change will force businesses to re-examine their supply chains, logistics management and pricing policies. 

There will be winners and losers, but international business will adapt and continue.  As a minimum, businesses should be checking whether they have an appropriate EORI, jurisdiction VAT registrations and any fiscal representation required, are geared up to account for and declare goods movements and duties, and have appropriate procedures to manage exchange rate fluctuations.  In the UK there is some government assistance for dealing with the change in the form of grants as well as initiatives for establishing freeports.

Infrastructure and equipment spending

Having removed tax allowances for expenditure on industrial buildings from April 2011 (previously around 4% per year), the UK has reintroduced a form of tax allowances for expenditure on structures – the structures and buildings allowance, now at 3% per year.

The recent UK spending review also announced an extension to the 100% tax allowance for expenditure on qualifying plant & machinery of up to £1m annually until 31 December 2021, after which it falls back to £200k.  While this allowance will be proportionately more significant for smaller businesses, it still represents an incentive to invest in improved equipment for those seeking to take advantage of the coming UK capital investment opportunities.

Digital services tax

The UK’s digital services tax came into force from 1 April 2020, and there are a number of other measures aimed at taxing profits of multinationals using intangible assets to make sales into the UK market but without a UK presence.  These include the ‘offshore receipts in respect of intangible property’ legislation, and a programme to closely examine the transfer pricing strategies and any profit diversion activities of larger businesses.

Taxes such as these will inevitably end up being borne by the consumer, so whether they do much to redistribute tax revenues from multinational businesses to market jurisdictions is open to question.  A more recent trend is the unwinding of certain cross border digital corporate structures to recognise a greater proportion of revenue and profit in the jurisdiction of the customer.  This may be being driven by the consequences of actions arising from the original 15 BEPS 1.0 reports, potentially making the threat of global apportionment of profit less of a problem.  If this trend continues, perhaps the OECD’s pillar 1 proposals for global apportionment may not be required?

Having incurred significant borrowing to support the economy, the UK government, along with other jurisdictions, will be looking to optimise their collection of taxes from larger and multinational businesses.  These are tax compliance issues businesses cannot afford to ignore, that are unlikely to become less complex if and when the OECD reforms concerning taxation of the digital economy are adopted.

Ensuring good tax governance practices and preparing for potential international tax disputes is something that should be high on the agenda for international business.