Although the government is proud of the UK’s position with its most competitive tax system in the G20, initiatives such as the BEPS (Base Erosion and Profit Shifting) project, which has already been adopted by 124 countries, making it harder to stand out from the crowd. With tax becoming an increasingly important global topic, the question needs to be asked: what does the UK offer multinational businesses and how will they differentiate themselves?
BEPS & ATAD
UK law has been strongly impacted by internationally agreed frameworks, primarily by its membership of the EU. Although direct taxation is generally determined by the Member States, several tax Directives have been unanimously agreed by the EU and therefore apply to all Member States. The link is even more distinct when it comes to indirect taxes, where EU directives are being implemented through UK law for taxes such as VAT, which are agreed on an EU wide basis. Additionally, fundamental freedoms imposed by European treaties cannot be violated by domestic law.
The UK has always actively supported the BEPS project and its 15 actions by being one of the first to implement many related measures. Furthermore, the EU’s ATAD (Anti-Tax Avoidance Directives), which enforce actions 2 (hybrid mismatches), 3 (controlled foreign companies or CFCs) and 4 (interest restrictions) and demand stronger general anti-avoidance rules (GAAR) and further action towards Exit Taxation, has extended involvement since 2016.
The table below illustrates the UK’s involvement and the impact both projects have had on the tax environment over the last four years.
Except for exit taxes, where members are allowed an extra year and interest restrictions, where states are allowed a transitional period up to 1 January 2024 when equally effective domestic rules are in place, ATAD measures had to be implemented by 31 December 2018 by all EU Member States. This swift and consistent approach decreases the possibility of tax avoidance on business profits.
The UK’s position
Provided that profits are taxed in the relevant states, according to the underlying framework and treaties, a possible advantage over other states presents itself when recognising the UK’s opportunity to set its own domestic tax laws.
Its open economy, skilled labour force and connected infrastructure are some of the factors from which the UK benefits, however from a tax point of view, the UK is also in a favourable position. As we can see from the table below, when taking state taxes into account, the UK corporation tax rate is the lowest in the G20. However, there are many other elements that influence multinational companies.
Specific tax reliefs, such as R&D relief, Patent Box and a range of investment and venture capital reliefs are another way of drawing attention from international businesses, particularly innovative firms who develop and commercialise intellectual property. When these reliefs are in accordance with the rules of the BEPS Inclusive Framework, EU harmful tax competition rules and EU competition law, then individual states are permitted to offer them. The table below illustrates the UK rates against those of several competing countries with such rules. However, comparing the UK’s position against its competitors is not straight forward because of the variation in qualifying criteria and design of the schemes.
1 plus state taxes of up to 12%
2 plus local taxes (lower rates apply to smaller companies)
3 lower tax rates apply to smaller companies
4 plus social surcharges (lower rates may apply to smaller companies)
5 15% plus surtax of 10% on income over BRL 240k, plus social contributions
6 reduced to 15% for income not benefitting from other preferential treatment, provincial rates up to 16%
7 depending on whether trading, plus higher rates apply for specific activities
* Denotes where measures are proposed in accordance with OECD actions
Although reliefs definitely create incentives, recent surveys indicate an increased value being placed on the stability and predictability of tax systems. The BEPS action plans, which are complex and often lead to significant changes in domestic tax systems, have therefore made the past few years rather challenging. The finalisation of implementing both the BEPS proposals and enhanced ATAD requirements, slowly reveals a clearer picture of how they will be applied. Nevertheless, companies based in the UK have always benefitted from the early adoption and clear statements of intent which the UK government issued along the way, making it easier to determine their exact tax position. Additionally, with most measures having already been implemented, the UK doesn’t expect any more significant changes to be made.
Adoption of tax treaties
* Denotes where further action may be required to ensure full compliance with OECD recommendations
~ Denotes where measures are proposed in accordance with OECD actions
The BEPS Multilateral Convention wants to implement the tax treaty related measures developed through the BEPS Project in current bilateral treaties as efficiently as possible. Although the UK already has Principal Purpose Test clauses in some treaties (which limit unintended treaty benefits) and hardly any major legislative changes are expected, the broader scope of the BEPS measures, adding better dispute resolution procedures and countering treaty shopping, will still have an important impact. As the Multilateral Convention contains a range of options and only applies when both parties to a treaty have ratified the Convention, taxpayers and advisers should make sure they are considering the latest version of an appropriate treaty before determining the tax treatment of a transaction.
The situation before BEPS clearly influences the data shown in the table above. Controlled Foreign Company provisions, designed to prevent the artificial diversion of profit to low tax jurisdictions were already widely implemented, whereas the adoption of corporate interest limitation had been more mixed due to a wider range of interest tax treatments. However, despite the generosity of the UK’s rules related to tax relief on corporate interest until 1 April 2017, the UK is yet again an early adopter of these rules.
ATAD definitely accelerated the process of adopting the BEPS recommendations for EU countries. However, the appetite for confronting tax avoidance is spreading internationally, which is evident with the US strengthening its anti-hybrid rules related to intragroup interest and royalty payments as part of US tax reform and France ensuring compliance with Action 5 by proposing alterations to its patent box regime in their 2019 Finance Bill.
Although many areas of EU law are adopted by UK law and thus would not immediately be expected to change, others rely on EU Directives. The Brexit uncertainty therefore creates a certain amount of doubt for any European group. For example, in the situation of a ‘no-deal’ Brexit, the EU Parent-Subsidiary Directive and Interest-Royalty Directive would no longer apply to the UK and firms relying on these would need to consider withholding taxes and whether bilateral tax treaties could be applied.
Taxation of the digital economy is another challenge for the UK and all other major countries alike, which will need to be tackled during the next few years. In case a joint solution can’t be agreed, the Chancellor already announced a Digital Services Tax from 1 April 2020, based on UK revenues above £25m for companies with relevant turnover in excess of £500m. The EU and several individual governments, such as Italy, India and Australia, have proposed similar measures. The US however, considers the digital economy as indivisible from the wider economy and is therefore more reluctant.
Collaboration vs competition
As the world’s major economies work together to eliminate tax avoidance, their tax systems will become increasingly similar, with just a few exceptions, such as the Irish tax system with its corporate tax rate of 12.5% and generous IP rules. Competing to attract investors and multinational businesses will therefore only become more challenging.
With its stable system, low tax rate and generous reliefs, the UK has to date managed to stay competitive. Brexit however, could endanger this position, so the challenge for the government will be to prevent disturbance of the delicate balance between taking the necessary actions against tax avoidance and building on the UK’s attractiveness as a destination for investment.