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Brexit may mean Brexit, but what will it mean for business?

Created: November 2016

The process of Brexit will be neither quick nor easy, with even the Chancellor warning that British businesses face a “rollercoaster.” Corporate tax partner Toby Ryland charts the potential ups and downs that lie ahead.

One of the many misleading assumptions made during the febrile pre-referendum atmosphere was that British businesses would vote en masse to remain in the EU.

The assumption was simple, but simply wrong. It reasoned that if businesses hate uncertainty above all else, why would they choose to swap the status quo for a prolonged bout of uncertainty?

While that logic may have held sway in most large corporates, and with many in the financial services and tech sectors, sizeable numbers of smaller business owners and entrepreneurs voted for Brexit.

But whichever side they backed, all British businesses are already being affected to some degree by the plunge in the Pound triggered by the UK’s momentous decision.

Many also face considerable upheaval during the extended period of uncertainty that now looms.

With divorce negotiations between the UK and the EU set to begin in early 2017, and Brexit itself not due to happen until 2019, it is still far from clear what a non-EU UK will look like.

However two areas likely to see significant change are taxation and trade – so what should businesses expect?

Battle lines are drawn

At its heart, the EU is a customs union and a single market. As a customs union, there are no tariffs on goods and services traded between EU member countries. And when trading with countries outside the bloc, member states all face the same tariffs – putting them on a level playing field.

With divorce negotiations between the UK and the EU set to begin in early 2017, and Brexit itself not due to happen until 2019, it is still far from clear what a non-EU UK will look like.

The single market means there is a shared VAT system that is harmonised and charged on a consistent basis across the EU.

As a trading nation, Britain has benefitted greatly from this arrangement – with even Brexiteers praising the ease and efficiency it brought to cross-border trade, even if they disagreed with the free movement of labour that came with it.

In the wake of the referendum, optimists suggested that the UK might be able to negotiate a “soft’ Brexit in which it left the EU but stayed in the single market.

However, by October the chances of that happening were looking ever more slim. At the Conservative Party conference, Theresa May made it clear Britain would not remain in the single market if doing so meant losing control of immigration.

Yet European leaders insist that the free movement of goods and services comes hand in hand with the free movement of people.

And so the first battle lines of the Brexit negotiations were drawn – the UK must choose between immigration controls or the single market. Britain can’t have both.

Growing signs that the government favours the former convinced the currency markets that the UK is heading for a traumatic “hard” Brexit, and the resulting fears sent Sterling plunging to record lows against both the Dollar and the Euro in early October.

The CBI and the UK manufacturers’ body the EEF responded by writing an open letter urging the government to preserve barrier-free trade with Europe.

It warned that if the UK left the single market and defaulted to World Trade Organisation (WTO) rules instead, 90% of UK goods traded with the EU would be subject to new tariffs.

And so the first battle lines of the Brexit negotiations were drawn – the UK must choose between immigration controls or the single market. Britain can’t have both.

However, in my view such tariffs would be cumbersome but manageable and are unlikely to be high, since high tariffs would not be in the best interests of either the UK or the EU.

Hold VAT thought

Changes to the most obvious direct tax on business were mooted within days of the referendum. One of George Osborne’s last acts as Chancellor was to suggest corporation tax be slashed to just 15%, though he gave no timeframe.

The rationale behind the suggested cut was to make the UK more attractive to foreign investors, and it was possible as the EU already allows its member states to set their own corporation tax as they see fit. However, the current Chancellor, Philip Hammond, may feel that such a cut in corporation tax is not needed – more will become clear when he delivers the Autumn Statement later this month.

By contrast the other major tax that affects businesses – VAT – is closely wrapped up in the EU mechanism. While nothing is expected to happen in advance of Brexit, once Britain leaves the EU, the UK could change how VAT is charged in the UK or even replace it completely.

One of George Osborne’s last acts as Chancellor was to suggest corporation tax be slashed to just 15%, though he gave no timeframe.

But this too is unlikely, as the cost to UK business would be high and completely unnecessary.

So in practice, the risk of double or non-taxation means that the UK VAT system is likely to continue to mirror the EU system even after the two separate.

With fundamental change unlikely, the main impact will be the imposition of import VAT when goods enter the EU from the UK and vice versa – which may have cashflow implications for businesses.

Negative impact on multinationals, but a boost for R&D

One aspect of Brexit that will hit multinational companies operating in the UK will be the loss of an EU-wide corporate tax “freedom” which allows organisations to make cross-border interest or royalty payments between subsidiaries free from withholding taxes.

This “WHT protection” is a key factor in the UK’s appeal to global corporations as a gateway to the EU. Without it, Britain may find it more challenging to attract inward investment at the same rate, however low its rate of corporation tax.

However there could be better news for small and medium-sized enterprises developing new products or services, as a post-Brexit UK will be free to extend research and development (R&D) tax relief. Together with the Enterprise Investment Scheme and Seed Enterprise Investment Scheme – and the specialist tax reliefs available to the creative industries – such tax incentives are currently classed as State Aid by the EU and are strictly limited.

While nothing is expected to happen in advance of Brexit, once Britain leaves the EU, the UK could change how VAT is charged in the UK or even replace it completely.

But these State Aid restrictions would cease to apply to Britain after Brexit, freeing Westminster to increase the value of the existing tax breaks, or introduce new tax incentives if it wishes.

Similarly Britain’s Patent Box regime – which was curtailed after EU opponents accused it of offering a competitive advantage to UK businesses – could be extended.

Divorce proceedings never run smooth

Theresa May has warned that she won’t provide a “running commentary” of her Brexit plans. But it’s safe to assume they will have to adapt in the face of tough negotiations with the EU.

With hard and soft Brexit factions already dividing the government, and the EU’s two biggest powerbrokers – Chancellor Merkel and President Hollande – drawing a line in the sand over Britain’s continued access to the single market, there is likely to be considerable horsetrading during the two-year Brexit negotiations.

The “three t’s” of tariffs, tax and trade will all be key battlegrounds. Businesses should accept that change is coming on all three fronts, even if the exact nature of that change won’t be thrashed out for some time yet.

Toby Ryland, Corporate Tax Partner
T 020 7874 7959
E tryland@hwfisher.co.uk