Neal Todd, a partner at Fladgate LLP, goes over what the Great Repeal Bill could mean for direct taxation, as the UK exits the EU
Whatever aspects of life the electorate thought they were bringing back under control by voting to leave the European Union in last year’s referendum, it is hard to believe that direct taxation was high amongst their list of priorities.
Taxing rights have been jealously guarded by the UK Parliament throughout our membership of the EU, but that’s not t to say that the UK tax code has been unaffected by European law.
In subtle but important ways, our taxing laws have been amended to comply with our treaty obligations to our European partners. For example, a UK company that receives a dividend from its subsidiary is now generally taxed in the same way, regardless of whether the subsidiary is resident in the UK or offshore.
Another example is that a group relationship can now be established through a parent company, irrespective of where in the world that parent company is located. If a UK resident company migrates to another territory it can pay its exit tax in instalments, but this was not always the case.
At an earlier time in our legislative history, the UK tax code was much more discriminatory, which is why there has been extensive litigation by major UK multinationals, such as Marks and Spencer and BAT. These companies claimed tax back from the UK Government on the grounds that earlier versions of the UK code were incompatible with one or more of the fundamental freedoms of the EU treaty.
The UK’s departure from the European Union will liberate the UK Government from the need to frame its tax laws in compliance with the strictures laid down by the free movement of capital, goods, services and workers.
Tax incentives will now be able to be offered selectively to regions and industries without any concern for falling foul of European state aid rules.
The Great Repeal Bill could mark a turning point in the history of taxation in the UK, but only if the Government of the day seizes the initiative.
The UK tax system in crisis, using a tax code that was designed for an analogue era but that is being applied to a digital world. Taxing multinationals on the basis of nineteenth century concepts of physical presence – tax residence and permanent establishment tests – makes little sense where multinational groups can organise themselves to arrange for profits to arise wherever they want.
That is why public confidence in the ability of the tax system to collect a ‘fair’ amount of tax from companies such as Amazon, Google and Starbucks, is failing.
This problem is not, of course, peculiar to the UK. It is a problem recognised by the G2O/OECD Base Erosion and Profit Shifting (BEPS) project that the UK is committed to.
The BEPS project is an attempt to tax profits where they arise – taking a substantive rather than a formalistic approach to the question.
An example is one of the last legislative measures introduced by David Cameron’s minority government. A ‘diverted profits tax’ was introduced into the UK tax system with the intention to tax multinationals operating in the UK as though they have a fixed base in the country, even in circumstances where they do not.
In the latest development of the BEPS project, 68 countries, including the UK, signed a multilateral convention on cross-border debt and equity investments, which amends hundreds of double tax treaties to introduce anti-avoidance provisions.
The BEPS project has a significant head of steam behind it, but there are grounds for speculation over whether it is entirely sensible for the UK to be such an active participant in the project.
Two reservations in particular are worth noting. The first is that the US has not committed itself to BEPS, and was not one of the 68 countries that signed the recent multilateral convention. This is significant, not only because the US is such a force in its own right, but also because large multinationals structure their affairs in a way that will minimise their non-US tax burden, in line with the US tax system.
The second reservation is that the BEPS project provides a series of sticking plasters to prop up the existing tax code. Rather than finding an entirely new basis of taxation, BEPS seek to make the existing system work more efficiently. But the UK may need something completely different, such as switching to a turnover based tax system in place of a profits related one.
Against the backdrop of the Great Reform Bill that will come in due course before Parliament, the UK Government may say that it does not have the time to promote a radical reform of the UK tax system.
But if the UK is to thrive outside of the EU, it needs to have a tax system that is attractive to outside investors while still raising revenue in a way that is seen as fair.
The question may, therefore, be whether the UK Government can afford to not put fiscal reform at the centre of the coming legislative changes.
Neal Todd is a Partner at Fladgate LLP.