British companies submit quarterly reports

In focus: Deal or No Deal - Brexit and its effects on transfer pricing

By Stuart MacLeod and Simon Niehoff called Renze
Without an extension of the negotiations or with the expiry of the deadline on March 29, 2019, the EU treaties will no longer apply to the United Kingdom.

As a personally affected Scot and someone who has spent a longer stay in Great Britain, the authors try to present Brexit and its consequences for companies (with a focus on transfer pricing) as compact, detailed and impartial as possible.

This article is part of the 41st issue of our newsletter “Transfer Pricing Perspectives DACH”.

1. Deal: If Theresa May and Parliament approve the trade agreement with the EU, Great Britain will leave the EU on March 29, 2019 and a so-called transition period will apply until the end of 2020. During this time, the country should adhere to all EU rules - it remains part of the customs union. In addition, further rounds of negotiations with the EU are to take place during this period. The transition phase gives companies a planning horizon to adjust to the new situation.

2. No deal: If Parliament rejects a trade agreement with the EU, the WTO trade agreement comes into force first. The UK is free to sign a trade deal with the EU or bilateral agreements at a later date. Companies would then have to come to terms with the new situation at short notice.

3. No Brexit: The European Court of Justice (ECJ) has decided that Great Britain can unilaterally - without the consent of the other EU member states - declare its resignation. Great Britain would then still be a member of the EU and there would be no changes for companies.

The following considerations are primarily based on a no-deal scenario, but could possibly also apply in the longer term under a deal scenario once the future trade relations between the EU and the UK are agreed.

Influence on business areas

In our opinion, those industries with regulatory and operational complexity are particularly affected in a no-deal scenario (Fig. 1), for example the automotive industry, pharmaceutical companies and financial service providers.

Expected business impact

Free movement of workers - business interruption and substance

Brexit has more far-reaching consequences than just transfer pricing. Understanding the documents and permits required to post EU citizens to the UK from March 30, 2019 is key. Affected are EU workers who work in the UK (e.g. key people) and who provide the necessary substance or, in the worst case, cause business to come to a standstill. The same goes for UK nationals entering the EU from March 30, 2019, although in some EU countries it may take 6 to 9 months to issue work permits.

In addition, there may also be restrictions for low-skilled / low-paid workers. Companies will probably use Brexit as an opportunity to rethink their operating models and increase the level of automation in future business. In addition, companies will conduct a more thorough analysis of their corporate structure to assess the cost-benefit ratio of relocating corporate headquarters, R&D or other functions to or from the UK based on the expected future operating environment.

Whenever there is a change in the business model, transfer pricing experts should sit at the table to assess the effects on the relocation of functions and the possible development effects - not to forget that restructuring can have an impact on group-internal financing agreements such as external capital. Within the group, it must be clarified which part of the company bears the costs for such cases.

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Not only do businesses need to ensure that they have the appropriate marketing authorizations and licenses to continue operating in the UK, they also face the added difficulties of moving goods and providing services in and out of the EU in a No -Cope with the deal scenario.

Most notable are the preparatory work to register and obtain the data required for customs (and sales tax) declarations. The focus is on talking to suppliers and customers who trade between the EU and the UK to understand if they are prepared for the changes and if it will have any potential impact on their business. This principle also applies to purchases and sales by affiliated companies that have corresponding contractual obligations.

Some companies are looking into alternative ways of serving the UK market, for example from other locations or manufacturing facilities outside the EU. They are also examining the impact these plans can have on transfer pricing. The assessment of these contingency plans on the risk control functions and the functional characterization plays a key role, for example inventories of British companies in the UK represent an additional risk for warehousing and processing.

EU law and jurisdiction

After Brexit, the UK will have the right to review, repeal and revise the EU regulations and EU directives that have been incorporated into UK law. These include, for example, withholding tax in relation to the EU Parent-Subsidiary Directive (for dividends), the EU Interest and Royalty Directive (for interest and license fees) and the EU Arbitration Directive (for mandatory arbitration). The British tax and customs authority HMRC has published guidelines in which it has promised arbitration in double taxation treaties.

The European Commission has repeatedly used its powers to contest state aid when it is believed that a company has obtained an unfair competitive advantage from the state (e.g. through tax advantages). The extent to which the UK will be bound by the state aid rules will be determined by the future UK-EU trade agreement.

Finally, there are a number of tax and transfer pricing issues on the EU's current agenda that Brexit could overshadow, such as the Common Consolidated Corporate Tax Base (CCCTB) and the digital tax - although it should be noted that the UK is already making progress on the digital Service tax, which is expected from April 2020.

After Brexit, Great Britain can freely decide - without any EU requirements - which tax rates, tax breaks and tax incentives should apply. UK-based companies will need to assess whether the company's current structure and operational model is still in line with the post-Brexit European market strategy. As risks and opportunities arise for businesses to and from the UK, transfer pricing experts will be needed to assess and implement the current and future effects.

As the exit date (March 29, 2019) is fast approaching and there are still a large number of ambiguities, we recommend companies plan for all eventualities to minimize business interruptions and risks. A particular challenge for transfer pricing experts will be the effects of restrictions on the movement of people (e.g. substance, functional profile and permanent establishment risk) and the movement of goods (e.g. inventory). In extreme cases, there may be a re-characterization of functional profiles, decisions about relocating or changing supply / value chains or restructuring of companies in order to reduce the identified continuation risks, which are to be assessed from the point of view of transfer pricing.

Regardless of whether it comes to a deal or no deal Brexit, there will still be changes in the long run as the UK redefines its relationship with the EU. As a result, the cost-benefit ratio of each change and adjustment will have to be assessed on a case-by-case basis.

"In focus: Deal or No Deal - Brexit and its effects on transfer pricing" is an article from issue 41 - February 2019 of our newsletter "Transfer Pricing Perspectives DACH". Further content of the 41st edition can be found here.