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Posts Tagged ‘UK Tax’

Craig-Walker-e1464790868125This Where in the World blog post is written by Craig Walker, Senior Tax Manager with Hawson’s Chartered Accountants.

From the argument over selling bendy bananas to the threat of an emergency budget, the EU referendum campaign has undoubtedly had its share of the headlines over the past couple of months.

The biggest headline now though is of course that the UK has voted to leave the EU.

So what happens next? Will the Brexit vote result in a complete overhaul of UK tax as we know it?

The purpose of this blog post is to briefly explore some of the potential tax implications of the UK’s decision to leave the EU. It is important to stress that the impact of Brexit on UK taxes is extremely difficult to predict at this stage, since many questions remain unanswered.

VAT

The EU has certainly had a significant influence on the UK tax system, perhaps most notably with regard to VAT. VAT is essentially an EU driven tax and leaving the EU could result in significant changes to this area of tax.

Whilst the UK may no longer be obliged to have a VAT system once post-exit terms have been agreed, it is fairly safe to assume that VAT will not be abolished given its contribution to the Treasury.

The UK will, however be free to decide which goods or services are eligible for reduced rates or exemptions. Freedom from strict EU VAT rules could, for example, allow the government to remove the 5% VAT charge on domestic fuel that is currently required by the EU – a change proposed by the Vote Leave campaign during the referendum.

Even if no amendments are made to VAT law in the UK, there could be changes in how HMRC applies VAT legislation because interpretations of the VAT rules would no longer be bound by decisions made by the European Court of Justice.

It is unclear at this stage how the VAT treatment of the UK’s trade with the EU will be affected – this will depend on the terms the UK is able to negotiate post-exit. It may be that trade could continue in much the same way as before if the UK is able to obtain access to the single market, or alternatively UK exporters may be subject to EU import VAT and Customs duties.

The Brexit is likely to create winners and losers for both businesses and consumers.

Emergency Budget

During the lead up to the EU referendum, the Chancellor warned that an emergency budget would be necessary to plug a potential revenue gap in public finances following a vote to leave. An emergency budget could of course bring significant changes to the UK tax system and possible tax rises.

The Chancellor has previously spoken about a 2% rise in the basic tax rate (currently 20%) and a 3% rise in the higher rate (currently 40%). He also indicated that the rate of Inheritance Tax might rise by 5% (currently 40%).

However, there is also an expectation that the government’s focus will be on delivering an upbeat message on the UK economy, in an attempt to calm the markets and boost the UK’s attractiveness as a place for doing business. Therefore, instead of making any immediate tax rises, the government may perhaps look to extend the period of austerity beyond 2020.

Business owners would certainly welcome clear timeframes and roadmaps for future UK tax legislation to help them through what will undoubtedly be a period of certainty.

Other Taxes

A total overhaul of UK taxes is unlikely to happen because of Brexit alone. A large proportion of the UK’s taxes are entirely domestic in nature, and the Brexit by itself won’t directly change any of these.

There may be small changes to the Gift Aid rules, which could affect UK taxpayers who wish to donate to EU-based charities. At present, UK taxpayers can make donations to EU charities and benefit from UK Gift Aid tax relief, however this approach could be changed post exit.

It will be interesting to see how the UK’s existing commitment to international tax agreements will be affected, both in terms of corporate tax and increased transparency.

In Summary

The UK tax system will probably remain largely unchanged following Brexit. The most significant changes are predicted to revolve about VAT, but most of these changes are expected to be gradually implemented and will emerge over time, as the UK negotiates post-exit terms. We will keep you updated.

The real, practical tax implications of the UK’s decision to leave the EU will vary from business to business.

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iStock_000003264435LargeRecently, Treasury Secretary Jacob Lew sent a letter to key members of Congress calling for the nation to embrace a “new sense of economic patriotism” and stop supporting corporations that are moving their tax home out of the U.S. to reduce their corporate income tax burdens by taking advantage of an existing loophole in the tax code.

The loophole, known as “corporate inversion,” is a transaction where a U.S.-based multinational group acquires a foreign corporation located in a country whose tax rates are lower than in the U.S. These reorganizations have the effect of changing the U.S. corporation’s domicile to a foreign country but typically results in little change to the U.S. operations of the entity. Although operations in the U.S. would continue to be subject to U.S. tax, the foreign operations conducted by the newly formed group would be subject to the lower foreign country tax rates. In addition, the foreign income is not taxed to the U.S. shareholders until dividends are paid. Moreover, the U.S. corporation may engage in earnings stripping transactions where deductible payments to the parent company reduce U.S. taxable income.

These transactions are particularly attractive to pharmaceutical and medical device companies who seem to have more choices of appropriately sized targets overseas and enjoy many benefits of a global presence. Popular destinations seem to be Britain, Ireland and Bermuda for their lower tax rates and other attractive R&D incentives. Transactions involving pharma and medical device companies have spiked in recent years, most notably the recent merger of Medtronic and Covidien, the attempted acquisition by Pfizer of AstraZeneca, and the AbbVie takeover of Shire, the largest inversion deal to date.

Here’s a summary of how the proposed inversion of Pfizer might have worked:

A newly created UK holding company would acquire the shares of both Pfizer and AstraZeneca. In the resulting structure, Pfizer and AstraZeneca would be subsidiaries of the UK parent and the former Pfizer shareholders would own 73% of the UK company and AstraZeneca former shareholders would own 27%. Pfizer hoped to shift profits to the UK, where the tax rate is around 21% as compared to 35% in the U.S.

For similar types of inversion transactions like the one proposed in the Pfizer deal, the U.S. government has attempted to curb the use of these inversion transactions:

  • Where shareholders of the U.S. corporation subsequently acquire over 50% of the new foreign parent corporation, section 367(a) causes a gain on the transfer of U.S. stock to the parent corp.
  • Where shareholders of the U.S. corporation subsequently acquire 60% or more, but less than 80% of the new foreign parent corporation, section 7874 prevents the U.S. corporation from using tax attributes, such as NOLs, to offset section the 367(a) inversion gain.
  • Where shareholders of the U.S. corporation subsequently acquire 80% or more of the new foreign parent corporation, section 7874 treats the new foreign parent company as a U.S. corporation for tax purposes, effectively removing any real U.S. tax savings from the transaction.

In triangular reorganizations, section 367(b) and Notice 2014-32 causes a potential taxable dividend as a result of a “deemed” distribution between parent and subsidiary on the acquisition of the target foreign corporation in exchange for parent stock.

Under Pfizer’s proposed new structure, the corporation would not have been considered a U.S. corporation for tax purposes under section 7874 because less than 80% of the foreign parent company would be held by the former U.S. shareholders. The U.S. corporation might have had to pay tax under the other anti-abuse regulations of section 7874 and section 367, however it planned to save over $1 billion in tax due to the tax rate differential alone, according to some reports. In other inversion transactions, some corporations were able to avoid the imposition of section 367(a) inversion gain by manipulating certain aspects of section 367(b)(“Killer B reorganization” rules), in order to make the transaction nearly tax free. Much tax planning goes into achieving these various tax savings from moving overseas and the transactions can get very complicated.

The letter from Secretary Lew calls for a lowering of the U.S. corporate income tax rate, among the highest in the world. At the very least, he asks Congress to pass laws to prevent or deter companies from using these inversion strategies, including retroactive laws to prevent tax savings on restructuring deals already agreed to, such as the recent Shire takeover. Despite bipartisan disagreement on how to address the tax loophole, tax reform in this area is likely to occur in some form. However, many tax practitioners and financial experts believe that these transactions will continue to be used at an increased pace until real reform occurs to lower U.S. corporate tax rates. In the meantime, patriotism aside, corporate management will maintain its allegiance to its shareholders and continue to strive to improve the corporate bottom line in the ever-increasing global economy.

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