The U.K.’s political landscape has completely changed since I wrote my last article for the Cayman Financial Review in early June.
Three weeks after that came the Brexit referendum, the delightful surprise of the vote for the U.K. to leave the European Union, closely followed by David Cameron’s resignation.
After a brief turmoil when no one seemed to know how to operate the Conservative Party’s internal rule book for leadership elections, Theresa May emerged as the new prime minister, not by election but by default as all the other candidates dropped out. George Osborne was removed as chancellor (“brutally sacked,” according to some press reports) and Philip Hammond appointed in his place.
So where does this leave the offshore world? What impact will Brexit, the new U.K. government, and the new government’s response to Brexit have on the global finance industry?
Inward or outward?
The big question is which response to Brexit the U.K. will adopt.
As we leave the EU, will we retreat inward to wallow in an insular “little Englander” mentality? Or will we return to the global expansiveness that once saw a small trading nation establish itself across the world? Or will we lose our nerve and end up with Brexit-lite, creeping shamefacedly back to Brussels to do a deal to keep things as much as possible as they were before?
Some signs are worrying, including the prominence of protectionist rhetoric in the campaign and the immediate post-referendum rush to analyze various forms of EU associate membership.
But other things are more positive. Twenty-seven countries, representing two-thirds of global GDP, announced almost immediately after the referendum that they wanted early trade agreements with the U.K., including not just the U.S. and Commonwealth giants such as Australia and India, but also quickly growing unrelated economies such as Brazil and China.
Role of offshore centers
Assuming the U.K. does opt for a global, expansionist economy, its historical and constitutional links with many of the world’s leading offshore finance centers could be a very valuable asset in recreating that international outlook.
Cayman and some of the other offshore finance centers play key roles in international investment and the global economy, and closer partnership with them could provide alternative channels for the U.K. into worldwide business once it loses some of its EU connections.
One of the main roles of offshore centers is to act as financial conduits, collecting capital and investing it around the world; the U.K. will want access to that stream of investment capital to offset any losses from Brexit.
But those relationships have, in some cases, been strained in recent years, particularly by the U.K. Treasury’s desperate desire to squeeze more tax out of its people. So the way the U.K. treats its associated jurisdictions will be important; will their attitude be one of openness or of inward-looking tax protectionism?
It is clear that the referendum was just the start of the process and the U.K. has major choices to make; the next few months will shape the direction of how it will use its newfound freedom of action.
Brexit and tax stability
Leaving the EU will have wide-ranging implications, including several important ones for international tax.
But it is important to avoid over-reacting. The U.K. has double tax agreements with every member of the European Union; these are all bilateral treaties, independent of the EU, and so will continue to operate in just the same way after Brexit is finalized.
Once it leaves the EU, the U.K. will lose the benefit of the Parent – Subsidiary Directive and the Interest & Royalties Directive, which allow payments of dividends, interest and royalties to and from companies in other EU members to be paid without withholding tax.
But the U.K.’s double tax treaties with the other EU member states already reduce those withholding taxes, in many crucial cases to zero; the U.K.’s tax treaties with Ireland, the Netherlands, France and Germany will still ensure that interest and royalties can be paid without withholding tax after Brexit.
There are a few gaps however; for example, the U.K.-Luxembourg treaty allows a 5 percent withholding tax on royalties and the ones with Estonia and Malta allow 10 percent withholding on both interest and royalties. Under some, such as Belgium or Italy, whether there is withholding tax can depend on the status of the loan or IP licence. These may require some adjustment of group structures to ensure that payments can continue to flow up the corporate chain without withholding taxes.
VAT is also deeply bound up in EU membership, but although the U.K. only adopted VAT as part of the process of joining, there is no talk of abolishing it or even of significantly changing the system. As time goes on, the U.K. and EU VAT systems will, no doubt, diverge slightly, but for now there will be little change.
Brexit and tax change
But although many tax matters will stay the same, there will undoubtedly be changes, and opportunities.
One welcome change will be that the U.K. will no longer be subject to the restrictions of the Code of Conduct on Business Tax. That will leave us more free to design competitive tax regimes, although only to the extent allowed by the OECD.
Presumably the U.K.’s associated jurisdictions, including the Cayman Islands, will also be able to escape the Code of Conduct; they were pressured to comply because of their connection with the U.K., so when the U.K. ceases to be a member of the EU, their reason for doing so will end. But that is one of the constitutional complications of Brexit that will have to be settled over the next couple of years.
In fact, the Code of Conduct had very little effect on the Cayman Islands, since it applies only to direct taxes, which Cayman has sensibly avoided imposing. Leaving it will be much more relevant to jurisdictions such as Jersey, where their tax systems used to impose income taxes on “local” companies but not on “international” ones, a regime that had to be changed when compliance with the Code of Conduct was imposed on them.
The U.K. will also be free of the EU’s State Aid rules; these were initially designed to prevent EU member governments from giving grants to failing businesses or industrial sectors, but recently they have increasingly been used to interfere in tax policy, with the EU Commission claiming that various tax exemptions amounted to a disguised subsidy and therefore were classed as illegal State Aid.
This is what the European Union recently used to strike down Ireland’s arrangement with Apple, levying a record-breaking retrospective 13 billion euro tax bill on the company that is causing a diplomatic row between the EU, Ireland and the U.S. Although I would not want to see the U.K. return to the days of subsidizing lame-duck businesses, the State Aid rules have been stretched too far; escaping them will avoid a lot of complications in setting future tax policy.
Leaving the EU would also have meant that the U.K. would no longer be subject to the Savings Directive (essentially the EU’s equivalent of the U.S.’s FATCA, a demand for automatic reporting or withholding taxes on interest payments to EU residents). Cayman and various other jurisdictions were pressured into signing up to that Directive because of their connections to the U.K., but technically they did so not via the U.K. but by a direct agreement with the EU. Perversely, the associated territories might have found it more difficult than the U.K. to escape the clutches of the Directive.
However, the Savings Directive is being wound down over the course of 2016 and 2017, to be replaced by compulsory reporting under the OECD’s Common Reporting Standard. By the time Brexit is complete, the Savings Directive should be generally irrelevant.
One issue that will need to be resolved, not to do with tax but important to offshore finance, is the U.K.’s access to EU financial markets under the MiFID passport. It would be a travesty if the U.K. was not able to obtain some sort of equivalence status, but depending on the precise deal obtained, there may need to be some reorganization of fund management groups that include the U.K., which will need careful tax planning.
The way forward
The main result of Brexit on tax policy is therefore that it gives the U.K. – and, to some extent, its associated territories – more freedom to set and develop its own tax structures.
That is why the future is so open; if the U.K. uses that freedom to return to nationalist protectionism, imposing more taxes on cross-border business, then it will be a disaster. The globalization of business and finance has been one of the great engines of growth over the last few decades, and if the U.K. uses its tax system to restrict that, it will make us all poorer.
Global finance is already struggling with the compliance burden of FATCA and the CRS; it does not need more restrictions from the U.K.
But alternatively the U.K. could embrace globalization and open its economy, becoming itself a trading and investment hub between Europe and the rest of the world.
One test of whether the U.K. will become more open or more protectionist will be its attitude to the Base Erosion and Profit Shifting (BEPS) project of the OECD (Organisation for Economic Co-operation and Development).
BEPS is a huge change to the international tax system, but there are increasing concerns that it has been rushed and that it fails to create a coherent new structure. Some areas are particularly worrying, in particular its treatment of intellectual property.
The EU is an enthusiastic supporter of the BEPS objectives and is implementing its own version, but once the U.K. leaves the EU it will be able to make its own decisions.
It is highly likely that the U.S. Congress will refuse to implement BEPS. Will the U.K. continue to follow the EU’s protectionist stance and impose the BEPS restrictions, or will it join with the U.S. in supporting a more open global economy?
The other test will be taxpayer confidentiality. The EU has been pushing various schemes for public disclosure of private information, including (for individuals) beneficial ownership of trusts and shares and (for companies) country-by-country reporting.
None of this is necessary to prevent tax evasion; the tax authorities have other, and generally more effective, ways of getting the information that they need. Even without the Common Reporting Standard, information exchange on request is now well-established and is generally functioning smoothly.
Instead, as we saw in the Panama Papers leak, this information will mostly be used by prurient journalists to gossip about any figures in the public eye whose personal financial information will now become public knowledge.
These disclosures make the U.K. look hostile to international investment, and by adding another layer of administrative costs they discourage global finance. If the U.K. continues to impose these requirements once it leaves the EU, it will be a bad sign that it is still stuck in protectionism rather than embracing an international outlook.
The new U.K. government
So which stance will the new U.K. government adopt? Will it adopt a protectionist attitude, more fearful that international investment will risk tax revenues, or will it look outward and embrace the opportunities that Brexit offers to reshape its tax system to make its economy more internationalist, and seek the advantages, the increased jobs and wealth that come from global engagement?
It is difficult to know which way Theresa May will move. She was Home Secretary for all the time that the Conservatives were in office, since 2010 (one of the longest holders of that difficult office). And before that, when her party was in opposition, she was variously spokesman on transport, employment, education and media, as well as doing a stint as party chairman.
She has therefore said very little about tax or economic matters, or even about international affairs, although her recent comments as prime minister have been encouraging:
“This country has always been one of the greatest trading nations, and as we leave the European Union we will have the opportunity to embrace new markets and opportunities as we export British innovation and expertise to the world. I am determined to make the most of the opportunities Brexit presents.”
Although May was in the “remain” camp in the EU debate, she has accepted the referendum result and has appointed a strong team of “leave” supporters to manage the Brexit process, in particular David Davis as “Brexit Minister” (formally Secretary of State for Exiting the European Union) and Liam Fox heading a newly created Department for International Trade.
Both of them are expected to be enthusiastic embracers of the opportunities Brexit offers for a more open and international economy.
The new chancellor
As the prime minister seems to have little involvement in finance or economics, those of us interested in tax are closely watching the new chancellor, Philip Hammond.
Although initial impressions are encouraging, he is something of an unknown quantity; one profile said that he “has long sought to guard his privacy by appearing to be less interesting than he really is” – a rare quality in a politician.
One very positive aspect is that he has much more experience in business than his predecessors. He didn’t become an MP until he was 42, which gave him time for a first career founding and running various businesses, including property, manufacturing, healthcare and oil, plus stints as a World Bank consultant. In contrast to his predecessor, who inherited money and had little experience outside politics, Hammond probably has more business experience than any chancellor since Neville Chamberlain in the 1930s.
Hammond was also a eurosceptic for most of his time in politics, although he supported Cameron’s “renegotiation” and campaigned for “remain” in the referendum, to some surprise. Had he publicly supported the “leave” camp, he might now have been prime minister, being less controversial than Johnson or Gove, the main leadership challengers from the “leave” side.
On fiscal policy, Hammond appears to be as “dry” as his image; he was George Osborne’s number two when the Conservatives were in opposition and so was one of the architects of the “austerity” manifesto, the commitment to eradicate the government’s deficit mainly by cutting government spending.
However, he was not given a Treasury post after the 2010 election because the Conservatives failed to win an outright majority and such an important post had to go to a Liberal Democrat under the coalition agreement. Instead, Hammond ran first Transport and then Defence, subsequently being made Foreign Secretary. This meant that he was not part of Osborne’s abandonment of austerity and subsequent over-spending, so the seemingly ever-increasing government debt cannot be blamed on him.
As foreign secretary he was involved with some of the offshore centers, and went on the record earlier this year to “reassure him [The Hon. Alden McLaughlin] of the U.K. support for the Overseas Territories,” and one of his early comments as chancellor was that the U.K. would continue to be “outward-looking,” “building on our productive, open and competitive business environment” to “attract companies to invest and grow in the U.K.” and ensure that we make a success of Brexit.
That is all encouraging, and Hammond appears to have genuinely sound pro-business instincts and to believe in balancing the budget; he has said he “strongly believes…the first responsibility of government is to promote economic stability, sound money and prudent public finances.”
That’s a good start for a chancellor, but unfortunately there are signs that he has fallen into the Treasury trap of believing that the way to “prudent public finances” is not to control spending but to squeeze ever more money out of the taxpayer.
His voting record as an MP is mixed, voting to cut taxes in some cases (increasing the income tax threshold; cutting corporation tax) but to increase them in others (primarily “green” and “sin” taxes); encouragingly, he voted against country-by-country reporting. But in general his voting record reflects his party’s position; it is probably going too far to read any personal beliefs into it.
But if his background is encouraging, his early actions as chancellor are less so; in the last few weeks the Treasury has announced that penalties for offshore tax evasion are to increase from 200 percent to 300 percent (not very important, as offshore tax evasion is very rare, but a worrying sign that the Treasury is still obsessed with headline-catching initiatives) and an alarming proposal to fine advisers over their tax advice, which could make it more difficult for companies to get proper professional assistance.
Uncertainty, but optimism
The way forward, and the stance of the new government and chancellor, is so far unclear, but the government seems keen to make Brexit happen and make it work, and the chancellor appears to have sound financial and business instincts.
The question is whether the government has the will to make the radical changes, of attitude as well as law, which are needed to take advantage of Brexit.
The U.K.’s associated offshore finance centers could be valuable partners in re-forging international ties for the U.K., if the Treasury can see the bigger picture and work with them.