This document has been updated on 14 January 2021.
The United Kingdom (UK) officially left the European Union’s (EU) single market on 1 January 2021. This document highlights some of the changes that occurred as a result of Brexit in respect of direct taxes and social security. The impacts of these often depend on the provisions of double tax treaties between the UK and individual EU Member States and specialist advice should be sought. We have also published a Q&A on the impacts of Brexit with relation to VAT & customs duty.
The impacts of Brexit on direct taxes will be far lower than that on indirect taxes due to:
- the limited competency of the EU on direct taxes, which tend to be considered domestic competencies by Member States
- the large number of bi-lateral tax agreements between Member States and 3rd countries (including the UK)
- a large amount of EU direct tax legislation being related to international, particularly OECD, initiatives – for example the BEPS actions or the Common Reporting Standard
However, there are some pieces of legislation that impact direct taxes in the EU, generally corporate income taxes, and we will briefly look at these.
The Trade and Cooperation Agreement (TCA) contains some provisions in respect of taxation but these tend to be broad policy commitments, such as both parties:
- recognising a commitment to good tax governance
- not reducing their standards below the OECD minimum standards in respect of:
- exchange of information re financial accounts, cross-border rulings, country by country reporting and tax planning arrangements
- rules on interest limitation, Controlled Foreign Companies and hybrid mismatches
- not reducing the levels of public country by country reporting by credit institutions and investment firms, other than for small and non-interconnected investment firms
- having an effective system of carbon pricing by 1 January 2021, covering greenhouse gases from electricity and heat generation, industry and aviation (within 2 years at the latest).
Both parties will establish central liaison offices to deal with issues arising and facilitate such processes as automatic exchange of information, recovery of taxes and simultaneous controls on taxpayers.
Corporate Income Tax
The Parent Subsidiary Directive
This Directive is only available to entities established in one Member State that have subsidiaries in other Member States, so no longer applies to the UK from 1 January 2021. The directive aims to exempt dividends and other profit distributions paid by subsidiary companies to their parent companies from withholding taxes – thereby eliminating double taxation of such income at the level of the parent company.
However, the practical impact of this change will be limited as the UK holds double tax treaties with many individual EU Member States, which typically exempt such income from withholding taxes, particularly in the case of significant shareholdings.
Currently, the UK has no withholding tax on dividends paid to non-residents, excepting a withholding tax of 20% in respect of Real Estate Investment Trusts. Withholding tax can apply to payments of interest and royalties in certain circumstances.
Interest and Royalties Directive
This Directive exempts any taxes imposed on payments of interest or royalties made by a company in one Member State, whether by withholding tax or by assessment, provided that the beneficial owner of the interest or royalties is a company established in another Member State or has a permanent establishment situated in another Member State. It no longer applies from the 1 January 2021 to transactions between group members when the recipient company is established in the UK.
As with the Parent Subsidiary Directive, it is anticipated that many of these arrangements will continue after 31 December 2021 due to existing bi-lateral double tax treaties between the UK and EU Member States. However, affected groups should review their payment flows to determine whether they will have to account for withholding tax (with refunds) on any such payments as the treaties may not include benefits equivalent to those under the Parent Subsidiary and Interest and Royalties Directives,.
The Mergers Directive
The Mergers Directive is intended to remove fiscal obstacles to EU cross-border re-organisations. From 1 January 2021 mergers, reorganisations and asset transfers between with UK and EU established companies no longer benefit from its provisions.
Problems could arise, for example, where a company transfers assets or liabilities to a UK company from a group member established in an EU Member State. Subject to any relevant provisions in the applicable bilateral double tax treaties, it is possible that exit taxation could be assessed at the point of transfer on the difference between the real value and the book carrying value of those assets or liabilities.
Directive for Administrative Co-operation
The Directive for Administrative Cooperation provides for data exchange between the tax authorities of Member States, specifically in respect of:
- income and assets related to employment income, pension income, directors’ fees, income and ownership of immovable property and life insurance products
- financial account information
- cross-border tax rulings and advance pricing arrangements
- beneficial ownership information
- cross-border tax planning arrangements.
The TCA includes ongoing cooperation on tax administration covering the areas covered by the DAC. However, it is unclear whether the UK will continue to use the existing EU reporting systems for exchanging such information.
In respect of DAC 6, covering automatic exchange of cross-border tax planning arrangements, the Directive specifies that it also covers situations where one side of the arrangement is in a 3rd country. From an EU perspective, this means that cross-border arrangements involving one Member State and the UK would still be reportable arrangements in the EU, subject to the application of applicable hallmarks.
On 4 January, the UK’s HMRC confirmed that its implementation of DAC 6 will be amended to reduce its scope to that of the OECD’s mandatory disclosures rules. Consequently, only arrangements falling under Category D of Part II of DAC 6 will need to be reported – broadly:
- arrangements that undermine the reporting requirements under automatic exchange of information and
- arrangements that hide beneficial ownership and involve the use of offshore structures with no commercial substance).
If the category D Hallmarks are met, it may then be necessary to report arrangements under Hallmark categories A, B, C and E.
This change will be retrospective.
Anti-Tax Avoidance Directive
Based on the OECD BEPS Actions, this directive has been written into law in all EU Member States and, in the UK, so the provisions are apply equally on either side of the Channel from 1 January 2021. The TCA contains a commitment that both parties will not reduce their standards below the OECD minimum standards for taxation, so it is likely that the provisions will remain aligned in at least the near future.
EU Social Security
The TCA arrangement continues the arrangement under the EU Social Security agreements – to ensure that EU individuals who work in different EU countries to only be subject to the social security regime of one of those countries.
Broadly, employees and self-employed persons will only be subject to the social security contributions of the State in which they work or provide their services. Civil servants will be subject to the laws of the State that employs them. Other individuals will be subject to the social security rules of the State in which they reside.
There are provisions where residents of one State that are temporarily employed or temporarily provide self-employed services in another State. Such ‘detached workers’ will be subject to the social security rules of their State of residence as long as the term of secondment doesn’t exceed 24 months (and the contract doesn’t replace another detached worker).
There are tie-break rules where an employee or a self-employed person pursues activities in more than one State.