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Brexit – VAT and Customs Duty Considerations

By March 21, 2016January 9th, 2024VAT news

With the date of the referendum now fixed for 23 June 2016 attention is turning to the VAT and Customs Duty considerations of a Brexit and questions are being asked by businesses about the likely timing of any changes and what these might be. The impacts can essentially be broken into 3 key areas for both taxes:
i) Changes to bottom line VAT and Duty costs
ii) Compliance and
iii) Systems

Timing and Transition
HMRC have not, understandably, published any specific VAT and Customs Duty guidance on the impact of an exit from the EU but the Government has published a useful paper ‘The Process for Withdrawing from the EU’. Crucially this details the legal process and the timelines which will be of interest to businesses. In simple terms:
• the UK would have up to 2 years to exit the EU from a legal perspective – this means current VAT and duty legislation which has an EU framework can remain in place during this period
• once the 2 year period is up, the UK can extend the transition period if it has the approval of the majority of Member States
• if no extension is applied for or granted, the UK ceases to be an EU Member State at the end of the two year period.
There would be a number of immediate impacts which are set out below. In terms of the legislation, leaving aside the extreme complexity of enacting new VAT and customs duty legislation, there is no obvious reason as to why we would not simply replicate existing legislation, adopting the same tax point, place of supply rules etc and the same reliefs and similar for customs duty. The elements that become irrelevant and require change are areas impacted by EU as opposed to non EU status. This is where the situation becomes a little complex for VAT – from an outbound perspective ie from a UK supplier’s perspective, HMRC would likely want to retain the tax impact of the EU versus non ‘flag’. This is due to the fact that, generally speaking, B2C transactions with EU counterparts create sticking tax whereas those with a non EU flag do not. Therefore, there would be a drop in VAT revenues unless the legislation is amended to create special rules specifying the VAT treatment of certain transactions where the counterpart is in one of the other 27 Member States.

Bottom Line VAT Costs
There is no obvious attraction in HMRC trying to make wholesale changes to the legislation on Brexit (there could be some politically motivated changes and we expect lobbying regarding the extension of the zero-rate in particular), but there is a question over whether the VAT rates would change. The current rate range is fixed within the EU framework but this would cease to be relevant post exit. It is unlikely that a VAT rate change (up or down) would be an immediate feature as the rates could be changed pre exit within the parameters of the current EU legislation, and the existing rate is competitive within the EU framework. The only caveat on this is the fact that the threat of an exit followed by a positive vote to exit could likely create significant economic turmoil for the UK, and VAT rate changes could be used to counter the impact.
As mentioned above, there are a number of areas of the EU VAT legislation which use an EU versus non EU flag to determine the VAT treatment of a transaction. These include (but is not limited to) the following:
– specified supplies – in the financial services and insurance sectors, transactions with non EU counterparts allow VAT recovery on costs – EU suppliers of such services to UK counterparts will see their VAT recovery rate boosted – this could in theory positively impact on pricing for UK buyers. The more crucial question for the sectors impacted in how their overhead VAT recovery rate is impacted by the loss of the EU/non EU flag
– TOMS – EU travel taxed under TOMS is subject to VAT, non EU travel is not. EU travel companies outside the UK will see their VAT costs reduced, making the UK a more attractive location. For UK businesses does revenue for all non UK destinations become UK VAT free? This seems unlikely given the revenue gap it would create.
– Use and enjoyment – this is applied to certain services and bites in a B2C environment in practice – if the UK becomes a non EU country the VAT treatment of such services used and enjoyed here would change and again UK suppliers could face a material change in the taxation of charges
– The distance selling rules would cease to be applicable to the UK which means that B2C sales of goods to EU customers could become VAT free exports. However, with the tightening of low value thresholds globally, Brexit could force UK retailers to look at maintaining an EU hub to make their sales to EU private customers as EU import procedures could put off potential customers

Bottom Line Costs – Customs Duty
For duty the position is more acute and clear in that, until new trade agreements are in place, the UK would lose the benefit of the duty rates afforded by being an EU Member State. This would increase the landed cost of many goods and, based on current experience it takes a good number of years to negotiate trade agreements.
In addition to the duty rate increasing on imports, current acquisitions from EU Member States become imports and thus attract customs duty at the new higher rate. The impact of the duty rate increase has featured in a number of articles in the mainstream press but the point about the change in status from acquisitions to imports has not been highlighted. This reclassification would create bottom line duty costs in addition to increased compliance costs – see next section.

On a positive note Intrastat and EC Sales Lists would no longer need to be completed and this would be very welcome for most businesses. However, where a business trades in goods, this would be replaced by the need to complete additional import and export declarations. This compliance function is often outsourced to a freight agent or customs broker. Therefore, whilst internal resource would be freed up by removing the need to report intra EU transactions for VAT and Intrastat purposes, an additional external cost would arise from the cost of completing the additional entries. The cost of this will vary depending on the commercial arrangements businesses have in place with their agents. This varies from say £1-£2 to around £35 per entry. On a related and perhaps more critical note, deferment account guarantees will need to cover additional amounts as the former intra EU acquisition transactions are reclassified as import transactions. HMRC are currently battling with the new EU customs duty regulations to be rolled out 1 May 2016 (The Union Customs Code, UCC). As with VAT it is likely there would be a clear preference to ape the existing legislative framework, albeit the volume of transactions captured will increase. Almost half of the goods leaving the UK are currently destined for the EU so a Brexit would double the number of export declarations currently processed.

From the perspective of VAT compliance, the UK would presumably lose access to the EU ‘one stop shop’ mechanisms (for electronic service and telecoms providers there is the non-union MOSS scheme that may become relevant) gradually being rolled out in various areas of VAT to remove the burden for a business requiring 28 VAT registrations across all Member States. This would be problematic for smaller to mid-sized businesses in the B2C arena in particular, as they would face a disproportionately high compliance cost and burden in needing to file VAT returns monthly, bi-monthly or quarterly in up to 28 locations in order to remain compliant and ensure their customers are not adversely impacted, for example by the changes in terms of the speed with which they receive their goods.
Triangulation is a simplification measure meaning EU businesses can be in a chain of 3 where the goods move from the original manufacturer in EU Country A to customer in EU Country C, without the supplier in EU Country B needing to VAT register in Country A or C. This easement would cease to be available and Supplier B in the UK would need to VAT register in multiple additional locations in the EU countries where such transactions currently take place and rely on the simplification.

Systems and Resource
Businesses will need to have sufficient warning of any changes to allow them to update IT systems etc where the status of a location has an impact on tax determination and this changes post Brexit. Invoice templates will also need to be changed and any new VAT registrations required as a result of the changes outlined above configured into the system.
One of the potentially critical systems issues however would be HMRC’s import and export system, CHIEF, and its ability to deal with a doubling of the number of transactions it processes as a result of the reclassification of intra EU trade. An overhaul to CHIEF is already tabled for 2016 to 2020 to enable it to meet the requirements of the UCC, and an exit from the EU would likely have an impact on this, in particular the need to ensure that the speed with which CHIEF processes entries is not impeded by the significant increase in volume.
On a more fundamental level there has to be real concern over HMRC resourcing for both VAT and customs duty in the event of a Brexit.

What Should Businesses Be Doing Now?
It is likely that most businesses trading in a significant way with other EU Member States will have initiatives running outside tax to identify the impact of a Brexit on the business. From a VAT and duty perspective the position will remain the same for up to 2 years post Brexit and therefore, as to what should be done now, this is likely to be limited to determining which of the factors outlined above (and any others) are relevant. Where there could be an impact on pricing depending on how changes are implemented, the wider business would need to be aware of this asap so that appropriate decisions can be made in the event of a vote to exit. For the other changes eg the increased compliance burden, there is no clear business case for doing much more at this stage than drawing up a short list of what these impacts could be so that a more specific and detailed piece of work can be done once we know the outcome of the Referendum – the short timescale on this means awaiting the outcome before doing a more detailed analysis is feasible.