Tax consequences of Brexit
Potential implications on the taxation of Italy-UK relations.
By means of the referendum dated 23 June 2016, the United Kingdom decided to leave the European Union. The “leave” vote does not imply the immediate exit of the UK from the EU since it is required for the UK to invoke Article 50 of the Lisbon Treaty. Consequently, negotiations between the UK and the EU would define the exact terms and conditions of the exit of the UK from the EU (i.e. the UK joining the European Economic Area “EEA” – as Norway, Iceland and Liechtenstein – and/or the UK joining the customs union).
Hereinafter, we analyse the main potential tax implications of Brexit and the treatment of the future Italy-UK relations focusing on the following topics:
- Withholding taxes applicable on financial flows between Italy and UK;
- Taxation of the M&A transactions;
- Impact on indirect taxation (VAT and customs); and
- Other considerations on specific tax regimes and dispute resolution mechanisms.
The EU has adopted a number of Directives aimed at removing double taxation in case of group of companies operating across different Member States. More specifically, the Parent-Subsidiary Directive eliminates withholding tax on dividends paid between associated companies located in different Member States, as well as the Interest and Royalties Directive eliminates withholding taxes on interest and royalty payments between associated companies located in different Member States. If the above mentioned Directives will no longer be applicable and no similar agreements will be negotiated between UK and the EU, double taxation would arise on dividend payments – as well as on interests and royalties payments – between an Italian parent company and a UK subsidiary or vice versa. As a consequence, in case of payment of dividend, interest or royalties from Italy to the UK, Italian withholding taxes will apply at domestic rates (respectively 26% withholding on dividend/interest, 30% on royalties). On the basis of the Double Tax Treaty (hereinafter, the “DTT”) currently in place between Italy and UK, the withholding taxes applicable on payments between associated companies would instead be the following:
- Dividends: according to Article 10 of the Italy-UK DTT, the withholding tax on dividends cannot exceed 5% in case the beneficial owner of the dividends holds at least 10% of the voting rights of the entity paying the dividends. In the other cases, the withholding tax can not exceed 15%;
- Interests: according to Article 11 of the Italy-UK DTT, the withholding tax on interests cannot exceed 10% in case the recipient is the beneficial owner of the interests;
- Royalties: according to Article 12 of the Italy-UK DTT, the withholding tax on royalties cannot exceed 8% in case the recipient is the beneficial owner of the royalties.
With specific reference to dividends, it is worth noting that the Italian domestic tax law provides for a 1.375% withholding tax on outbound dividends distributed to companies located in EU/EEA countries. Therefore, the circumstance that the UK would or not join the EEA would be extremely relevant to define the withholding tax applicable on dividends.
Through the Merger Directive, the EU adopted a tax deferral mechanism aimed at removing tax obstacles to cross-border reorganizations involving associated companies situated in two or more different Member States. More specifically, the Merger Directive provides for the deferral of the taxes that could be charged on capital gains derived from the restructuring transactions. This mechanism ensures the tax neutrality of restructuring transactions by deferring the capital gain taxation until the assets transferred are effectively realized.
In case the tax deferral regime would no longer be applicable in UK as a result of Brexit, the capital gains deriving from the cross-border reorganizations involving UK would be immediately taxable.
Additionally, the tax treatment of the deferred capital gains would have to be further investigated upon Brexit since it can not be excluded that the tax deferral regime would be interrupted – even if the assets are not yet realized – also with regard to the cross-border reorganizations realized before Brexit.
As a consequence of Brexit, the UK would no longer be required to apply VAT Directives and Regulations. Therefore, the sale of goods between Italy and the UK would be no more considered as intra-EU transactions but as import/export. Also the VAT regime applicable to the provision of services would be strongly impacted by Brexit and specific regimes as the Mini One Stop Shop (the “MOSS” that applies to services provided via electronic means) would no more be applicable in the UK.
Additionally, Brexit may – depending on the effective negotiations between the UK and the EU – result in the exit of the UK from the customs union. Indeed, the UK could also remain in the customs union in accordance to a separate agreement to be stipulated with the EU (as for Turkey). In such a case, there would be no significant differences from the current customs discipline applicable to the trading of goods within the EU. On the contrary, customs – and duties where applicable – would be applicable on the trading of goods between the UK and the EU Member States.
Brexit would also impact on the applicability of specific Italian tax regimes and EU dispute resolution mechanisms that are applicable only to companies located in the EU Member States/EEA countries.
For instance, the “horizontal fiscal unit regime” that has been recently introduced in Italian tax law requires that the holding company is resident in a EU Member State or in an EEA country with which Italy has signed an exchange of information agreement. Consequently, assuming that the UK would leave EU without entering the EEA, Italian subsidiaries controlled by a UK entity would not be able to opt for the horizontal fiscal unit regime.
With regard to dispute resolution mechanisms, the EU Arbitral Convention establishes a procedure to resolve disputes where double taxation occurs between enterprises of different Member States as a result of an upward adjustment of profit for transfer pricing purposes of an enterprise of one Member State.
Similarly, most of the bilateral DTTs provide for a mutual agreement procedure (hereinafter, “MAP”) that – in accordance with Article 25 of the OECD Model Tax Convention – can be invoked by the taxpayer in case of transfer pricing adjustments in order to avoid double taxation.
Differently from the MAP, the EU Arbitral Convention imposes an obligation on the Member States to achieve a result eliminating the double taxation. Indeed, if no agreement is achieved between the Member States within two years, the case has to be analysed by an independent advisory body and Member States shall conform to the decision of the independent advisory body – or adopts a different agreement – in order to avoid double taxation.
Consequently, the exit of the UK from the EU would result in the inapplicability of the EU Arbitral Convention implying that double taxation arising from transfer pricing adjustments on intercompany transactions between Italy and the UK could be eliminated only through MAPs that, however, do not provide for a result obligation.