Of all the possible consequences of Brexit, tax has been a major talking point for businesses operating in the UK and in EU member states like Italy; a key UK business partner. As the March 29th deadline gets closer and with trade agreements still to be agreed, the estimated 44% of UK exports to the European Union may become more expensive due to indirect taxes and more complex to administer.
At a recent workshop, organised by the Italian Chamber of Commerce and Menzies, the tax realities of what a “Hard Brexit” might look like were widely debated alongside the necessary tactics for tackling this outcome.
When we talk of indirect taxation, the key topic is VAT (Value Added Tax, called IVA in Italian) and customs duties. The current common and streamlined system, set within a context of free movement of goods and absence of duties, is likely to be replaced by a much more articulated procedure. Exporting goods from the UK to the EU, for example, would entail zero-rated VAT for the former, but also require the completion of customs formalities; which for the latter may incur numerous charges – i.e. import-related VAT, duties, and customs formalities. For EU to UK exports, the system would work in a specular manner.
Possible solutions to this increased complexity include:
- The UK Government establishing postponed accounting for import VAT, in order to facilitate liquidity.
- Creating a stock of goods in the UK, to be distributed to local consumers, as well as one in the EU to continue benefiting from the Single Market and the Customs Union (UK hub/EU hub).
Direct taxation in Italy
Rebecca Wilkinson – Corporate Tax Partner
While the impact of a “Hard Brexit” on indirect taxation of goods is undeniable, its effects on direct taxation must also not be overlooked. In this case, the main impact will be on withholding taxes on dividends, interest and royalties (e.g sums paid to use a patent or intellectual property etc).
As a general rule, direct taxation is controlled by the individual Member States but should be exercised in line with EU Law and without breaching its fundamental freedoms. EU Directives, however, overrule domestic law in some areas of trans-national taxation. For example:
- The EU Parent Subsidiary Directive ensures that dividend payments from associated companies to parent companies of different Member States are generally free from withholding tax and
- The EU Interest and Royalties Directive generally ensures that payments of interest and royalties between associated companies of different Member States are free from withholding tax.
Crucially though, in the event of a “Hard Brexit”, such Directives would no longer be applicable and the taxation of dividends, interest and royalty payments will revert the terms set out in the UK-Italy Double Tax Treaty. Importantly, this does not fully eliminate withholding taxes in all cases and could mean going from a system with no withholding tax, to a much more complicated double-taxation system. This would impose numerous administrative formalities such as formally applying for a reduction in the standard withholding tax rate, reporting and paying withholding taxes to the tax authorities and making claims for double tax relief where withholding taxes have been applied. The result could be an increase in the overall level of taxation for international groups.
In simple terms, this would imply numerous formalities connected to the request for exemption from the double taxation, or the request for a reduction in the applied rate.
What does the future hold?
The general climate of uncertainty, the number of variables involved and the range of possible international implications related to Brexit, are underlining how complicated the current situation is. Operating a business within such complexity is never easy, but in the case of indirect and direct tax, getting ahead in order to minimise the possible impact of Brexit on the present is key.