Britain: A Tax haven after Brexit?

Adiba is currently studying for her LLB at Middlesex University, Dubai. Her main areas of interest are human rights and public law. Outside of the law, Adiba enjoys running, cycling and drawing.

Any free trade agreement should be balanced, ambitious and wide-ranging… A level playing field must be ensured, notably in terms of competition and state aid, and in this regard encompass safeguards against unfair competitive advantages through, inter alia, tax… and regulatory measures and practices.

European Council

A no-deal Brexit, as Theresa May sees it, 'wouldn't be the end of the world'. These were her words as she tried to brush off recent warnings from her Chancellor of the Exchequer that Britain’s exit from the EU without a trade deal could damage long-term economic growth. However, as the Guidelines for Brexit Negotiations published by the European Council in April 2017 show, the EU has long been concerned about such a prospect: Brexit, they worry, might signal the emergence of a Britain with new trade policies that potentially undercut the Continent's economy. 

While this may not, of course, be the end of the world as Theresa May knows it, such an outcome is still concerning enough that in January 2018, the EU published a strategy paper threatening to counter the ‘clear risks’ that would come from, amongst other things, the UK’s plans to boost economic growth by slashing taxes.

In this paper, the EU observes that the UK is 'likely to use tax to gain competitiveness', noting that it already has a low-tax economy involving ‘a large number of offshore entities’. Since these characteristics are some of the hallmarks of tax haven jurisdictions, some have argued that the loosening of EU regulations after Brexit could worsen current tax avoidance and lead to the UK becoming a tax haven. 

In light of this, taxation looks set to become an increasingly politicised issue. The debate as to whether the lower tax rates and new incentives for companies that might follow Brexit could lead to Britain becoming a tax haven is complex; there are unlikely to be any straightforward answers to such questions.

However, some light can be shed on how current legislative measures to tackle tax avoidance are likely to be affected by Brexit.  This article examines this, and also shines a light on why tax avoidance has become an increasingly emotive issue, particularly as its connections to the Brexit process are being gradually uncovered. 

Background: Tax Avoidance in the Spotlight

The 2016 ‘Panama Papers’ leak brought into the spotlight 11.5 million leaked files detailing the wealthy individuals and companies who avoid tax in their own countries by using tax havens. Further revelations in the 2017 ‘Paradise Papers’ leak also highlighted the sheer scale of continued tax avoidance.

Both these scandals enhanced public perception of tax avoidance as an unfair pursuit: most accept the obligation of paying taxes in return for the benefits of access to the NHS, state education, the welfare state, and other public policy investments. Many, however, would also love to see their tax bill reduced. As such, many foster the belief that, if the tax havens involved in the scandals could be closed down and high-earning companies could be made to pay up, it would be possible to raise the money needed for those investments and implement a widespread reduction to tax burdens across all members of the public.

However, this overlooks that much of the tax avoidance uncovered by the scandals is legal. Companies and individuals are allowed to arrange their activities in a tax efficient way. It is only if those activities are done with the sole purpose to reduce the tax paid that tax evasion occurs. Tax evasion – for instance, where companies or individuals fraudulently deceive the government as to their taxable income – is not legal. The line between the tax avoidance and tax evasion is blurry, particularly for the average lay person.

Following Brexit, it is widely accepted that the UK will have find new forms of income to fill holes in public spending. This, combined with concerns about its effect on economic growth, has seen argue that a long overdue crack down on tax avoidance and tax evasion has become even more urgent.

Going about this task, however, is not as straightforward as it seems: tax law is complex. Indeed, if the government could squeeze as much money from companies as it wants, then it would already be doing so. At present, it simply cannot. 

Taxing Businesses After Brexit

At present, government tax policies largely dovetail those of a school of economists who have argued that taxes on companies – far from being made higher – should, instead be lowered to drive growth and facilitate investment.

Much of the Brexit negotiations have been focused on striking a compromise between the interests of businesses in the UK, and those in the EU or in third countries. The UK government wants, as far as possible, for businesses to continue making goods and services in the UK.

One way the UK government can convince businesses to stay in, or move to, the UK is by lowering the tax that companies have to pay on their profits: this corporation tax is already low in the UK. Indeed, while the rate of corporation tax in 2007 was 30%, it is currently 19%, and will fall to 17% in 2020. It is worth noting too, that because rates of corporation tax are not harmonised by the EU, further rate reductions can be taken, with or without Brexit.

The UK has largely succeeded in making its tax system as attractive as possible to businesses. Indeed, despite the uncertainty that Brexit has caused, in 2017 there were 5.7 million private sector businesses in the UK – an increase of 197,000, or 4% since 2016. This can be attributed partly to the UK's low corporation tax rates, but also to its attractive territorial system that also encourages companies to relocate there. A territorial tax system involves taxing companies on the basis of where they make their profits. It benefits both the UK and multinational companies: the latter can be based in the UK without paying UK tax on any international profits, while the former enjoys all the jobs and investment this brings.

However, one of the biggest challenges that comes from operating a territorial tax system - particularly in the age of globalisation and multinational companies - is ensuring that profits made in the UK are taxed in the UK, and profits made internationally are taxed in the corresponding countries. This challenge is linked heavily to the concept of tax avoidance. As it becomes easier to take advantage of the increasingly multinational nature of companies and the quick uptake of the territorial tax system by governments worldwide, companies have been able to come up with new corporate structures that concentrate tax burdens in certain low-tax jurisdictions.

The risk that the UK may become one of those jurisdictions is why, in the EU's view, Brexit poses a threat to the need for a unified international and regional approach in tackling tax avoidance.

Tax Avoidance: Taking Back Control on a Long Uncontrollable Problem

International Measures on Tax Avoidance

Though Brexit may give the UK greater freedom to redesign certain aspects of its tax system, the aim of remaining economically competitive must be balanced with ensuring it continues to comply with its numerous international obligations imposed by a range of global measures against tax avoidance that the UK is still a key part of.

Most notable of those measures is the Action Plan on Base Erosion and Profit Shifting (BEPS) that is managed by the Organisation for Economic Cooperation and Development (OECD) and for which the UK has led some of the negotiations. BEPS is a major project that aims to ensure that multinational companies pay tax where they make their profits. This way, profits can no longer be shifted from one country to another for the sole purpose of tax avoidance.

Serious efforts like these to oppose tax avoidance which the UK has been involved with seem difficult to reconcile with its supposed aim of becoming a more competitive tax regime after Brexit. However, it is clear that in this respect, Brexit will have no loosening effect that pushes the UK towards becoming a tax haven; these are, after all, international obligations and measures.

Indeed, with the UK simultaneously negotiating tax arrangements with the EU as a whole – as well as with individual EU members – it may well be that this gives less time to focus on pursuing a more competitive tax regime. These multiple new arrangements could even turn out to be such a restriction on the UK’s ability to push for new tax incentives that Brexit might limit the UK’s corporate tax system in much the same way as did membership of the EU. 

EU Measures on Tax Avoidance

Above all, it is the UK’s regional commitments to tackling tax avoidance that will be most affected by Brexit. This is especially so where UK law and EU law are in conflict. For example, the UK’s introduction of the Diverted Profits Tax in 2015 – an anti-avoidance provision aimed primarily at preventing multinational companies from exploiting tax mismatches – had at one point been questioned as potentially contravening EU law. The UK was criticised for introducing domestic law that could be incompatible with the freedom of establishment and free movement of capital provided for in EU Treaties. After Brexit, this provision might be more likely to continue unchallenged – on those particular grounds, at least.

Additionally, the EU Anti-Tax Avoidance Directive – which comes into effect in January 2019 – may not apply to the UK after Brexit. Since there is a lot of overlap between this directive and the BEPS, there may not be too much of an impact on the overall state of the UK’s current tax avoidance measures. Even so, following Brexit the UK might be able to exercise greater flexibility in how it chooses to implement the BEPS measures.

Unilateral Measures on Tax Avoidance

Lending support to the idea that Brexit will not hinder the continued crackdown on tax avoidance, the government has shown itself to be capable of making quite a lot of progress in unilaterally tackling the issue. In May 2018, the Sanctions and Anti-Money Laundering Act 2018 was passed, making it a requirement that companies registered in UK overseas territories had to publicly disclose their beneficial owners. This increase in transparency could make tax havens less attractive places to invest in and be a positive step for the UK as it shows its commitment to tackling tax avoidance in overseas territories.

Another effort involves the HMRC’s specialist investigation department opening 839 investigations into UK taxpayers with assets in offshore tax havens over the past year. HMRC will continue its targeting of 100 prosecutions of high-net worth people and companies each year until 2020. The investigations, prompted by the Panama Papers scandal, have so far been effective at monitoring tax avoidance, with the HMRC’s offshore unit securing £5bn in extra tax from its compliance activities last year.

Domestic legislation has also been strengthened as the fight against tax avoidance continues. The new ‘Requirement to Correct’ legislation allows HMRC to impose penalties on individuals and companies if it discovers that they have underpaid tax owed in relation to offshore assets. These legislative provisions should ensure that any more tax incentives after Brexit would not make it any easier to avoid tax. 

Changing the Tax Law? 

The UK tax code continues to evolve, with the statutes and official guidance on tax rules doubling between 2009 and 2016 to reach 10 million words. Its length and complexity makes it easier for clever accountants to find loopholes in the legislation to exploit for their clients. As Henderson J in Revenue and Customs Commissioners v D'Arcy [2007] emphasised, there will be: 

[C]ases which will inevitably occur from time to time in a tax system as complicated as ours [where] a well-advised taxpayer has been able to take advantage of an unintended gap left by the interaction between two different sets of statutory provisions.

While Brexit brings along new freedoms to make changes in the tax area, solutions to make the system simpler and more efficient take a lot of time and resources to implement. However, one relatively simple idea for reform that has been put forward by the Institute for Fiscal Studies involves changes in calculating corporation tax. Corporation tax is currently imposed on taxable profits, which are profits that can be adjusted for tax-reporting purposes allowing accountants to find ways to lower the reported number and thus reduce the company’s tax liability. However, taxing companies on their accounting profits – the company’s total earnings – without allowing any adjustments might mean that more tax could be collected, whilst also simplifying the process.

Conclusion

The worry that Brexit might make it easier for lower tax rates and tax incentives to push Britain into becoming a tax haven is, for the most part, overstated. Indeed, a lot of the steps that the government will take – such as lowering corporation tax – are going to happen anyway, with or without Brexit. The UK also continues to play a critical role in international measures against tax avoidance, the OECD BEPS project being the most notable example. Any attempts to make domestic tax policy more attractive must be weighed against the risk of going against this huge commitment.

Accordingly, removing itself from the constraints of EU directives could give the UK greater freedom to improve the tax system’s competitiveness, but it must first balance this against the regional, international, and unilateral measures that have already been put into place – to neglect this risks walking further along the tax haven route. 

This is a route that has, for a long time, been facilitated by loopholes in UK tax law. The tax system is still overly complex, and reform could ensure that the rules are more aligned with clear principles. Without the influence of European law, this would require a lot of rethinking. Theresa May’s ‘not the end of the world’ mindset does seem gloomy, but if it encourages politicians to make the best of what happens, then one of the first things to work on would be a serious discussion on changing the tax system for the long term. The Chancellor’s worries about long-term economic growth are, indeed, warranted if the tax system stays the same and businesses are not contributing as much as they could to a post-Brexit economy.