What happens when your European home base is no longer in the European Union? This episode of Culture of Compliance looks at the tax compliance implications of Brexit. Sabrina Serafin interviews Malcolm Joy International Tax Partner with Frazier & Deeter and William Morrison Director with Essentia Global Services.
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Culture of Compliance: Braving Brexit in 2021
This transcript was assembled by hand and may contain some errors.
It has been edited for readability.
Sabrina Serafin Welcome to Frazier & Deeter’s Culture of Compliance podcast series where we discuss compliance as a competitive advantage in today’s marketplace. I’m Sabrina Serafin, Partner and National Leader of Frazier & Deeter’s Process, Risk & Governance Practice.
Today, we’re getting an update regarding Brexit, the long-awaited departure of the UK from the European Union. Our guests today are Malcolm Joy, the Leader of Frazier & Deeter’s UK practice, and William Morrison, the Director of Client Services at Essentia Global Services.
Essentia specializes in global indirect tax management, helping businesses manage their worldwide compliance and cost burden with respect to VAT and similar taxes. William and Malcolm, welcome to the podcast.
William Morrison Thank you very much and thanks for having me on.
Malcolm Joy Thank you, Sabrina. Good to be here.
Sabrina To set the stage for our US audience, we thought it would be a good idea to have Malcolm give us a recap of the impact of Brexit.
Malcolm Thanks, Sabrina. Yes, Britain was part of the European Union from the early 1970s, and it effectively gave us a single market for goods and services with no tariffs, no customs duties, unlimited border checks within Europe. We also had free movement of labor and free movement of capital within the European Union. And our departure from the EU means we now need to reestablish rules for all cross-border activity.
Sabrina Now, as I recall, the vote for Brexit was in 2016 and there were several extensions during the negotiations, right?
Malcolm That’s right. There were many rules which needed to be agreed, including rules around health regulation, food safety, competition, fishing rights, etc. and it proved to be a very drawn out and even quite acrimonious negotiation over the years. Technically, we actually left the European Union on the 31st of January 2020, but there was a transition period agreed up until 31st of December 2020. It was only when the transition period ended that the old rules fell away. One of the most important areas where we are now seeing the changes in our VAT regime.
Sabrina Of course. Malcolm, for our US audience, they may not be familiar with VAT. Can you explain what VAT is and how does it differ from the United States tax system?
Malcolm VAT is a type of sales tax, but there are a number of key differences around how it operates. in particular, businesses that have to charge VAT often are able to recover some of the VAT on the costs that are incurred by them. I think some of the key differences we are going to see, though, as Britain has moved out of the European Union are around how that VAT regime in Europe is applied and how we now have a separate VAT regime for the UK. Some of the main issues are going to be around registrations and accounting for the VAT. Hopefully, it shouldn’t be too much of an extra cost, if businesses file appropriately.
Sabrina Since VAT is a key part of understanding the implications of Brexit, let me ask William some questions. William, can you tell us more about how Brexit is impacting companies with a presence in the UK?
William The UK has, for a long time, been a first landing point for a lot of US companies that are looking to invest in Europe because of legal and language ties, and has been seen as quite a good base for European operations. We deal with a lot of US companies that are now having to face the fact that the EU base is no longer in the EU and react to that in one way or another.
William I think there are two things on the levels of impact of Brexit, and there are a lot of US service providers that have come into the UK and there are a lot of US goods, distributors, or manufacturers. We’ve got limited time today, so I’m proposing to focus a little bit more on goods than on services. Simple reason for that, is that the single market has never been a perfect creation and has never been as deep in services as it was in goods. There’s never really been quite so much of a single market for services, and as a result, the impact of the UK leaving the single market in the service world has been much less severe.
This doesn’t necessarily mean that if you’re a service provider, you’ve got a free pass and nothing has changed, but most of the rules with respect to services that the fundamentals are still the same. It’s only really for the goods providers that the landscape has very dramatically shifted.
William The key thing, of course, for people moving goods between the UK and the EU either direction is that there’s now a customs border in between. Up until the end of January, you could just have a distribution point in the UK for Europe, load a truck and get driving same as you can have a distribution point in Atlanta and get driving for Florida. That’s no longer the case. Goods have to face customs clearance in order to leave the UK and enter the EU, or vice versa. That has a number of tax implications. The ones are VAT and customs duty. Customs duty is a bottom-line cost at a border. You’ve got to pay it and generally speaking, you don’t get to claim it back.
So, either you, the supplier, or the customer is going to end up having to pay something for those goods when they’re dutiable. That was a major issue in the UK, because our economy is so intertwined with the rest of Europe. It would be akin these days to putting up a customs border between Wisconsin and Minnesota. It would create a great deal of chaos. So, we have a free trade agreement with the EU, which means that there’s zero customs duties on UK originating goods in the EU, and zero customs duties on EU originating goods in the UK.
That’s removed duty as a cost, but it does leave three problems. The first problem is, although you’ve zero percent duty, you’ve still got to submit your customs declarations.
So, the guy in the lorry still gets stopped and has to do his papers. In the modern economy, where we’ve got a lot of real time deliveries these delays at customs, even if they’re not leading to any tax being paid, can be very critical things for people. The second thing is that it creates VAT implications, but the third thing is that the UK-EU Free Trade Agreement only covers UK and EU originating goods. It doesn’t cover non originating goods. A very common scenario, up until now has been that, for instance, you have a US company that distributes US made goods out of the UK into the EU. If you’ve got that going on right now, although we’ve got a free trade agreement, when the goods rock up at the EU border, they’re not UK origin goods, even though they’ve just come from the UK, they’re US origin goods.
So, the US origin duty rates apply, which means a lot of businesses distributing out of the EU face the challenge of unexpected duty costs as the goods move from the UK to the EU. The challenge is a potential double duty cost: you’ve paid a duty to get the goods from the US into the UK, but then you need to pay it again to get the goods from the UK into the EU.
Sabrina Of course.
William There are special reliefs that you can apply for and special suspensions in the UK. To get rid of the UK duty end of that, if they’re just passing through, but they’re bureaucratic and they involve things like special permissions and guarantees and things. So, even if you make the bottom-line costs go away, (a.) it adds to your admin costs and (b.) you have to have it in mind, you need to do it. Otherwise, the problem will come and bite you when you actually try and move the goods.
So, that was a quick look through the customs duty side of things. I think on the value added tax (VAT) side of things, obviously value added tax is a consumption tax. Somewhat similar to the sales taxes that crop up in the US state, and somewhat similar to what some states are trying to do at the moment in terms of making sure that there’s a flat playing field for interstate trade and make sure that the goods are taxed and where they’re consumed, the EU has rules that specify that goods attached to the VAT where they’re consumed or if they’re shipped cross-border, where they arrive. At the moment, when UK goods leave for the EU, they can be zero rated for that. There’s no UK in that problem because they’re leaving the UK, so that’s the end of our concerns with them.
But upon arrival in the EU, there’s not just duty to pay the border, but there’s VAT to pay at the border as well. A common point of friction now between suppliers and customers, is who gets to pay that now? This is driven by the delivery terms that are in contracts of supply. There are international standard delivery terms with things like DDU (Deliver Duty Unpaid) or DDP (Deliver Duty Paid), depending on which of those terms are applying, you can get different VAT outcomes. If, for instance, your UK base is supplying into customers in the EU on a DDP basis, deliver duty paid basis, they’re responsible for being the importer at the EU, as well as being the exporter from the UK. Not legally, anybody can be the importer, but commercially, because the DDP contract obliges them to do that.
Unfortunately, the consequence of you being the importer in the destination country means that you have to pay local VAT and you actually become registerable as a local VAT taxpayer, because after having cleared those goods for import in your own name, the subsequent transaction becomes a domestic transaction. So, you almost take ownership of those goods in the local VAT system and become a local VAT taxpayer. We’re seeing a lot of UK, US companies distributing out of the UK, maybe entered into distribution delivery of contracts with customers back in the day when there was a single market and nobody worried too much. Deliver Duty Paid, Deliver Duty Unpaid, doesn’t matter.
But if it’s got that Deliver Duty Paid in it now, it’s got that kind of time bomb, that all of a sudden there is a customs border now, you as a supplier are responsible for it and therefore you have to register locally. That can become a particular problem if you’ve got DDP contracts with a number of different EU countries, because unfortunately, there’s still no such thing as a single EU VAT registration. If you’re delivering DDP to ten different countries in the EU, you suddenly become registerable for that in 10 different countries in the EU, which composes quite an administrative problem.
Sabrina Is that right?
William Yes. In fact, that’s how things are working now from the 1st of January.
Sabrina William, what are some of the questions that companies with a UK presence should be asking themselves right now?
William I think the important thing is to be quite diagnostic on this and to really look at what are your product flows? Perhaps go through a full list of your product flows, where goods are coming from if you’re buying them, where they’re going to if you’re selling them and what are the delivery terms, both that your suppliers negotiated with you and that you have negotiated with your customers? Then for each product flow, it’s possible to diagnose, what is the impact of this customs border? Is there one at all? And if there is and it’s a negative one, then what can we do about it?
Then from that, to start to distill out some action points, take corrective action. I think I would reassure most businesses that Brexit is not the end of the world. There’s considerably more admin in some circumstances, and it makes some transactions more difficult, but there’s a solution to these things.
Most of the people who are getting in trouble at the moment and have their trucks stopped, their product rotting and things like that, are mainly people who have not actually implemented that solution on a timely basis. I won’t say that there’s a magic formula for solving every problem, but most of these problems for most people are manageable with a little bit of preemption and thought.
Sabrina Thank you so much, William and Malcolm. I appreciate you joining us today to help our audience better understand Brexit and the compliance ramifications.
William My pleasure.
Malcolm Yes, thank you, Sabrina.
Sabrina And to our audience, thank you for listening to Frazier & Deeter’s Culture of Compliance podcast. Please join us for our next episode as we continue to discuss transforming compliance requirements into investments in your business.