The deadline of the withdrawal of the UK from the EU according to article 50 of the Treaty on the European Union is set to expire on 29 March 2019. In the absence of a deal, after such date, EU law will cease to apply in relation to the UK, potentially generating significant consequences for the direct tax treatment of cross-border activities between the UK and the member states of the EU. This article, finalised on 11 March 2019, is meant to address some of the direct tax consequences that UK businesses may face in other member states because of Brexit.
From a direct tax perspective, after Brexit the UK will be treated as a third (i.e. non-EU member) state for the purposes of:
In terms of primary EU law, the UK withdrawal will imply that the EU fundamental freedoms laid down in the EU Treaty will no longer apply in relation to cross-border economic activities between the UK and the other EU member states, with the exception of the free movement of capital which will still apply as its scope covers also cross-border activities vis-à-vis third (i.e. non-EU member) states.
In terms of secondary EU law, the UK withdrawal will trigger the non-application of the EU Directives, including, in particular, the following direct tax Directives:
In respect of direct tax Directives, it should be noted that certain provisions concerning the application of EU direct tax Directives are included in the draft withdrawal agreement of the UK from the EU published on 14 November 2018 (‘the Draft Agreement’). Particularly, the provisions of Annex 4 of the Draft Agreement lay down a commitment from the UK to continue to apply the provisions of its domestic law that transpose certain Directives such as the ATAD and the DAC. The issue arises as to whether, in the light of this commitment (assuming that the Draft Agreement will be approved by both the UK and the EU), EU member states should treat the UK as an EU member state for the purposes of the application of their domestic legislation that implements the provisions of ATAD and DAC (e.g. when it comes to transfer of residence from an EU member to the UK). In this respect, it should be noted that the provisions of the Draft Agreement lay down a commitment for the UK but not a corresponding obligations for the other EU member states.
The domestic legislation of member states sometimes provides for favourable tax regimes subject to the EU status of the companies involved. Such favourable tax regimes were often, but not always, provided to make domestic legislation EU law compliant. For instance, over the past years, member states were often led to amend their tax legislation in order to eliminate discriminations between cross-border and domestic situations that could be considered as in breach of the fundamental freedoms in the light of the judgments issued by the CJEU. It is worth making a few examples of the aforementioned tax regimes subject to the EU status (reference will be made to Italian legislation), in order to understand how Brexit may impact on their applicability.
First, the judgment in Commission v Italy (Case C-540/07) concerns discriminatory taxation of outbound dividends (subject to a 27% withholding tax at source) vis-à-vis taxation of dividends distributed to resident companies (subject to 27.5% income tax at the level of the recipient on a taxable amount of 5% of the gross dividends). As a result, Italy introduced a new withholding tax rate of 1.375% for outbound dividends (not benefiting from the Parent Subsidiary directive) paid to companies liable to income tax in other EU or EEA member states. (Indeed, 1.375% is equal to 27.5% times 5%. This withholding tax rate has been further reduced to 1.2% in response to the reduction of the corporate income tax rate from 27.5% to 24%.)
After Brexit, such a favourable domestic tax regime will no longer be applicable to UK companies. In this example, the application of the favourable 1.2% tax regime should be preserved due to the application of the free movement of capital; however, depending also on the complexities of the EU law argument, relying on the free movement of capital may imply the risk of litigation with the local tax authorities.
A second example concerns horizontal tax group regimes. After the judgment in the case SCA Group Holding (Case C-39/13 to Case C-41/13), several member states amended their tax group regimes allowing resident subsidiaries whose shares are held directly by the same non-resident parent company to form a fiscal unity. Such amendments were made in order to avoid further infringements of the freedom of establishment, after the CJEU had stated that the group tax regime of a member state that does not allow two subsidiary companies held by a parent company in another member state to form a fiscal unity between them is in breach of the freedom of establishment to the extent that such parent company would have been able to form a fiscal unity with its subsidiaries had it been a tax resident of such member state.
Horizontal tax group regimes introduced by member states are often conditional on the EU status of the holding company. Therefore, after Brexit, sister companies held by the same UK parent may not be able to form a horizontal tax group. Moreover, Brexit may have an impact on horizontal tax groups already in place at the time of the withdrawal of the UK from the EU. Indeed, the fiscal unity might be discontinued because, after the withdrawal, the UK company will not qualify any more as company resident of an EU member state.
In order to avoid this adverse consequence, groups headed by a UK parent might consider reviewing their holding structure through the set up of a holding company resident in a European member state before Brexit. In this second example, following Brexit, the taxpayer cannot rely on the free movement of capital since the relevant freedom is the one of establishment.
Third, favourable tax regimes subject to the EU status may be provided for a purpose other than to make domestic legislation EU law compliant. For instance, Italian law provides for an exemption for outbound interest paid to EU banks in relation to medium-long term loans granted to Italian businesses. The goal of the legislation is to ease the access of Italian businesses to debt. Such a favourable tax regime will cease to apply after Brexit (a separate issue, outside the scope of this article, is whether other exemption regimes for outbound interest may remain available), and it cannot be extended by the operation of the free movement of capital since it does not imply any discriminatory treatment.
Brexit may impact also pre-Brexit transactions. Indeed, business transactions or group reorganisations carried out before Brexit might have benefited from regimes that were subject to EU status. Brexit might impact on such transactions and might determine adverse consequences.
An example concerns exit taxation. After the judgment in National Grid Indus (Case C-371/10) and other judgments of the CJEU on the compatibility with the freedom of establishment of exit taxation regimes, several member states granted to companies that transferred their tax residence to other member states, and lost their tax residence in their member state of origin, the option to defer the payment of the exit tax due upon transfer. Usually, the deferral is discontinued if the company transfers from its member state of destination to a non-EU member state. Brexit might have adverse consequences for companies that transferred their tax residence to the UK and deferred the payment of the exit tax in their member state of origin. Indeed, the loss of their EU status because of Brexit might be deemed to be equivalent to a transfer of residence to a third country and, therefore, might trigger the obligation to pay immediately the outstanding amount of the exit tax.
Brexit might have significant impact on outbound dividend/interest flows from companies established in EU member states to companies resident in the UK. Indeed, dividend/interest payments made by companies tax resident of another member state might be exposed to withholding tax at source without the possibility to benefit from the exemption granted by the Parent Subsidiary Directive, the Interest and Royalty Directive or by other domestic regimes of member states that reduce or eliminate taxation at source subject to the EU status of the recipient.
UK companies receiving dividends/interest from their EU subsidiaries should, therefore, check the provisions of the applicable double tax conventions, or the applicability of other domestic tax regimes in the respective member states of residence of the subsidiaries, in order to understand whether Brexit might trigger an increase of the tax burden on dividends/interest received from EU subsidiaries.
In order to mitigate the adverse consequences of Brexit, multinational groups might wish to review their corporate structure by creating an EU sub-holding company located in an EU member state. The use of an EU sub-holding should take into consideration the recent judgments rendered by the CJEU on 26 February 2019 in joined cases N Luxembourg 1 (Case C-115/16), X Demark (Case C-118/16), C Danmark I (Case C-119/16) and Z Denmark (Case C-299/16) on the Interest and Royalty Directive (‘IRD cases’); and in joined cases T Danmark (Case C-116/16) and Y Denmark (Case C-117/16) on the Parent Subsidiary Directive (‘PSD cases’). Particularly, in such cases, the Grand Chamber of the CJEU laid down landmark guidance on beneficial ownership and abuse for the purpose of the aforementioned Directives.
As far as beneficial ownership is concerned, in the IRD cases the CJEU held that, for the purpose of the Interest and Royalty Directive, the notion of beneficial owner must be construed in the light of the Commentary on the OECD Model and its amendments. It is not entirely clear from the text of the judgment whether the 2014 changes to the Commentary should be relevant. The doubt arises from the fact that such changes took place after the introduction of the Interest and Royalties Directive and from the fact that, at one point, the CJEU seems to refer only to the changes of the Commentary on the beneficial ownership concept until 2003, but not to the 2014 changes (see para 92, which refers to OECD developments described under paras 4–6, but not to para 7). The CJEU further holds that, if the recipient of the interest is not the beneficial owner but the beneficial owner qualifies for the Interest and Royalties Directive, the benefits of the Directive are still applicable.
In the PSD cases, the CJEU (see para 111) seems to hold the view that the benefits of the Parent Subsidiary Directive are subject to the fulfillment of the beneficial ownership condition, despite the lack of any beneficial ownership clause in the text of such Directive.
As far as abuse is concerned, the CJEU held that member states have an obligation to deny the benefits of EU legislation in case of abuse (irrespective of the existence of domestic or treaty-based anti-abuse provisions). The CJEU also stated that abuse requires both that the purpose of the legislation is not achieved (objective element) and that obtaining the tax advantage is the main purpose or one of the main purposes of the taxpayer (subjective element). Finally, the CJEU ruled that the existence of an abuse shall be determined on the basis of a factual analysis and that the following indicia may be taken into account:
The above cases highlight how the concept of abuse under EU law continues to evolve and they will have a significant impact on most international group structures and the flow of funds from EU subsidiaries to EU parent company controlled by non-EU entities.
The deadline of the withdrawal of the UK from the EU according to article 50 of the Treaty on the European Union is set to expire on 29 March 2019. In the absence of a deal, after such date, EU law will cease to apply in relation to the UK, potentially generating significant consequences for the direct tax treatment of cross-border activities between the UK and the member states of the EU. This article, finalised on 11 March 2019, is meant to address some of the direct tax consequences that UK businesses may face in other member states because of Brexit.
From a direct tax perspective, after Brexit the UK will be treated as a third (i.e. non-EU member) state for the purposes of:
In terms of primary EU law, the UK withdrawal will imply that the EU fundamental freedoms laid down in the EU Treaty will no longer apply in relation to cross-border economic activities between the UK and the other EU member states, with the exception of the free movement of capital which will still apply as its scope covers also cross-border activities vis-à-vis third (i.e. non-EU member) states.
In terms of secondary EU law, the UK withdrawal will trigger the non-application of the EU Directives, including, in particular, the following direct tax Directives:
In respect of direct tax Directives, it should be noted that certain provisions concerning the application of EU direct tax Directives are included in the draft withdrawal agreement of the UK from the EU published on 14 November 2018 (‘the Draft Agreement’). Particularly, the provisions of Annex 4 of the Draft Agreement lay down a commitment from the UK to continue to apply the provisions of its domestic law that transpose certain Directives such as the ATAD and the DAC. The issue arises as to whether, in the light of this commitment (assuming that the Draft Agreement will be approved by both the UK and the EU), EU member states should treat the UK as an EU member state for the purposes of the application of their domestic legislation that implements the provisions of ATAD and DAC (e.g. when it comes to transfer of residence from an EU member to the UK). In this respect, it should be noted that the provisions of the Draft Agreement lay down a commitment for the UK but not a corresponding obligations for the other EU member states.
The domestic legislation of member states sometimes provides for favourable tax regimes subject to the EU status of the companies involved. Such favourable tax regimes were often, but not always, provided to make domestic legislation EU law compliant. For instance, over the past years, member states were often led to amend their tax legislation in order to eliminate discriminations between cross-border and domestic situations that could be considered as in breach of the fundamental freedoms in the light of the judgments issued by the CJEU. It is worth making a few examples of the aforementioned tax regimes subject to the EU status (reference will be made to Italian legislation), in order to understand how Brexit may impact on their applicability.
First, the judgment in Commission v Italy (Case C-540/07) concerns discriminatory taxation of outbound dividends (subject to a 27% withholding tax at source) vis-à-vis taxation of dividends distributed to resident companies (subject to 27.5% income tax at the level of the recipient on a taxable amount of 5% of the gross dividends). As a result, Italy introduced a new withholding tax rate of 1.375% for outbound dividends (not benefiting from the Parent Subsidiary directive) paid to companies liable to income tax in other EU or EEA member states. (Indeed, 1.375% is equal to 27.5% times 5%. This withholding tax rate has been further reduced to 1.2% in response to the reduction of the corporate income tax rate from 27.5% to 24%.)
After Brexit, such a favourable domestic tax regime will no longer be applicable to UK companies. In this example, the application of the favourable 1.2% tax regime should be preserved due to the application of the free movement of capital; however, depending also on the complexities of the EU law argument, relying on the free movement of capital may imply the risk of litigation with the local tax authorities.
A second example concerns horizontal tax group regimes. After the judgment in the case SCA Group Holding (Case C-39/13 to Case C-41/13), several member states amended their tax group regimes allowing resident subsidiaries whose shares are held directly by the same non-resident parent company to form a fiscal unity. Such amendments were made in order to avoid further infringements of the freedom of establishment, after the CJEU had stated that the group tax regime of a member state that does not allow two subsidiary companies held by a parent company in another member state to form a fiscal unity between them is in breach of the freedom of establishment to the extent that such parent company would have been able to form a fiscal unity with its subsidiaries had it been a tax resident of such member state.
Horizontal tax group regimes introduced by member states are often conditional on the EU status of the holding company. Therefore, after Brexit, sister companies held by the same UK parent may not be able to form a horizontal tax group. Moreover, Brexit may have an impact on horizontal tax groups already in place at the time of the withdrawal of the UK from the EU. Indeed, the fiscal unity might be discontinued because, after the withdrawal, the UK company will not qualify any more as company resident of an EU member state.
In order to avoid this adverse consequence, groups headed by a UK parent might consider reviewing their holding structure through the set up of a holding company resident in a European member state before Brexit. In this second example, following Brexit, the taxpayer cannot rely on the free movement of capital since the relevant freedom is the one of establishment.
Third, favourable tax regimes subject to the EU status may be provided for a purpose other than to make domestic legislation EU law compliant. For instance, Italian law provides for an exemption for outbound interest paid to EU banks in relation to medium-long term loans granted to Italian businesses. The goal of the legislation is to ease the access of Italian businesses to debt. Such a favourable tax regime will cease to apply after Brexit (a separate issue, outside the scope of this article, is whether other exemption regimes for outbound interest may remain available), and it cannot be extended by the operation of the free movement of capital since it does not imply any discriminatory treatment.
Brexit may impact also pre-Brexit transactions. Indeed, business transactions or group reorganisations carried out before Brexit might have benefited from regimes that were subject to EU status. Brexit might impact on such transactions and might determine adverse consequences.
An example concerns exit taxation. After the judgment in National Grid Indus (Case C-371/10) and other judgments of the CJEU on the compatibility with the freedom of establishment of exit taxation regimes, several member states granted to companies that transferred their tax residence to other member states, and lost their tax residence in their member state of origin, the option to defer the payment of the exit tax due upon transfer. Usually, the deferral is discontinued if the company transfers from its member state of destination to a non-EU member state. Brexit might have adverse consequences for companies that transferred their tax residence to the UK and deferred the payment of the exit tax in their member state of origin. Indeed, the loss of their EU status because of Brexit might be deemed to be equivalent to a transfer of residence to a third country and, therefore, might trigger the obligation to pay immediately the outstanding amount of the exit tax.
Brexit might have significant impact on outbound dividend/interest flows from companies established in EU member states to companies resident in the UK. Indeed, dividend/interest payments made by companies tax resident of another member state might be exposed to withholding tax at source without the possibility to benefit from the exemption granted by the Parent Subsidiary Directive, the Interest and Royalty Directive or by other domestic regimes of member states that reduce or eliminate taxation at source subject to the EU status of the recipient.
UK companies receiving dividends/interest from their EU subsidiaries should, therefore, check the provisions of the applicable double tax conventions, or the applicability of other domestic tax regimes in the respective member states of residence of the subsidiaries, in order to understand whether Brexit might trigger an increase of the tax burden on dividends/interest received from EU subsidiaries.
In order to mitigate the adverse consequences of Brexit, multinational groups might wish to review their corporate structure by creating an EU sub-holding company located in an EU member state. The use of an EU sub-holding should take into consideration the recent judgments rendered by the CJEU on 26 February 2019 in joined cases N Luxembourg 1 (Case C-115/16), X Demark (Case C-118/16), C Danmark I (Case C-119/16) and Z Denmark (Case C-299/16) on the Interest and Royalty Directive (‘IRD cases’); and in joined cases T Danmark (Case C-116/16) and Y Denmark (Case C-117/16) on the Parent Subsidiary Directive (‘PSD cases’). Particularly, in such cases, the Grand Chamber of the CJEU laid down landmark guidance on beneficial ownership and abuse for the purpose of the aforementioned Directives.
As far as beneficial ownership is concerned, in the IRD cases the CJEU held that, for the purpose of the Interest and Royalty Directive, the notion of beneficial owner must be construed in the light of the Commentary on the OECD Model and its amendments. It is not entirely clear from the text of the judgment whether the 2014 changes to the Commentary should be relevant. The doubt arises from the fact that such changes took place after the introduction of the Interest and Royalties Directive and from the fact that, at one point, the CJEU seems to refer only to the changes of the Commentary on the beneficial ownership concept until 2003, but not to the 2014 changes (see para 92, which refers to OECD developments described under paras 4–6, but not to para 7). The CJEU further holds that, if the recipient of the interest is not the beneficial owner but the beneficial owner qualifies for the Interest and Royalties Directive, the benefits of the Directive are still applicable.
In the PSD cases, the CJEU (see para 111) seems to hold the view that the benefits of the Parent Subsidiary Directive are subject to the fulfillment of the beneficial ownership condition, despite the lack of any beneficial ownership clause in the text of such Directive.
As far as abuse is concerned, the CJEU held that member states have an obligation to deny the benefits of EU legislation in case of abuse (irrespective of the existence of domestic or treaty-based anti-abuse provisions). The CJEU also stated that abuse requires both that the purpose of the legislation is not achieved (objective element) and that obtaining the tax advantage is the main purpose or one of the main purposes of the taxpayer (subjective element). Finally, the CJEU ruled that the existence of an abuse shall be determined on the basis of a factual analysis and that the following indicia may be taken into account:
The above cases highlight how the concept of abuse under EU law continues to evolve and they will have a significant impact on most international group structures and the flow of funds from EU subsidiaries to EU parent company controlled by non-EU entities.
