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What now for taxes as hung Parliament throws UK into uncertainty?

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With 42.4% of the vote, the Conservative Party has lost its majority in Parliament and may now have to rely on the Democratic Unionist Party (DUP) for getting their tax measures passed.

On the other hand, the Labour Party made major gains, winning 29 seats with 40% of the vote share. The outcome goes against the predictions made in April that the May government would easily get a super-majority in this election.

A coalition government also means even less tax certainty as Brexit negotiations loom.

“The general election results have come as a surprise and any hopes of any political certainty have been dashed for the time being,” said Alicia Videon, partner at McDermott Will & Emery. “The impact for Brexit negotiations is unclear. This is on top of a deteriorating domestic economy and global economic and geopolitical uncertainty.”

Officially, Prime Minister Theresa May called the snap election in the hope of gaining a sizeable majority to strengthen her hand in negotiations with the European Union. The lack of a majority in Parliament may change the agenda for corporate tax cuts as the UK government goes into talks over its withdrawal from the European Union (Brexit).

“In the short term, the election result will inevitably create uncertainty about the direction of corporate tax policy,” said James Ross, partner at McDermott Will & Emery. “However, it probably also increases the likelihood of a ‘soft’ Brexit, so groups worried about losing the benefit of EU directives to minimise withholding tax on intra-group interest, dividend and royalty payments may want to hold fire before unwinding their UK holding company structures.”

Brexit comes before tax cuts

When the Conservatives came to power in 2010, the rate of corporation tax was 28%. Subsequent cuts have lowered the rate to 20% and the May government plans to reduce it further to 17% by 2020. The Conservative Manifesto reiterated the government’s commitment to a low tax model for business and individuals.

“The Conservatives had intended to oversee a continued reduction in the rates of corporation tax,” George Bull, senior partner at RSM UK, told International Tax Review. “A strong Labour opposition that wishes to increase corporation tax rates may frustrate Conservative objectives.” Though the implications of the election results have a much wider impact.

“What is most important is not the level of corporation tax, but how we will leave Europe in terms of the Customs Union and also the impact on VAT,” said Bull. “Where we end up after Brexit is more important than what the corporation tax rate will be because paying a bit more on profits is simple compared to what the impact on imports and exports might be.”

“There have been efforts to update the customs system for trade after Brexit goes through. This project had greenlight status but now the light has turned to amber,” Bull continued. “And this is a serious problem because a ‘hard’ Brexit with a software upgrade not fit for purpose would be everybody’s nightmare.”

Leadership troubles risk Brexit success

From the outset, the UK election seemed to be a foregone conclusion. It looked like May would claim an easy victory with many predicting a super-majority for her party, allowing her to negotiate Brexit as the UK’s governing party. However, the campaign trail proved treacherous for the Conservative leader and Labour’s standing in the polls surpassed initial expectations. It began to look like a much closer race in the last few weeks.

“Basically she thought strike now, lock it in and then yeah, okay it might strengthen your hand a bit in terms of the negotiations and it will dramatically strengthen your hand in control of your own party,” said Steve Keen, professor of economics at Kingston University. “Well, it blew up in her face in the same way that the Brexit vote did.”

In 2015, the combined vote of the Conservatives and UK Independence Party (UKIP) amounted to 48% of the electorate. It was widely assumed that May’s stance on Brexit would allow the party to win over the UKIP vote, whereas such voters would never turn towards Labour. But, as the campaign progressed, it became clear that the election would not be decided on this issue alone.

Since the results have not produced the mandate May wanted, there have been questions raised about whether or not she will be able to lead the country. “I don’t think May is going to survive the result,” said Keen. “She has so weakened her own position that she’s shot herself in the foot with what she claimed was the motivation for the election.”

The elections result is likely to have an impact on major decisions by UK companies and international investors, who had been proceeding on the basis of a continuing Tory majority. “Businesses are likely to react with caution until a government is put in place, as concerns of Labour’s proposed changes to the tax regime become perhaps a little more real,” said Videon. “Real estate investors and others will no doubt worry of being hit by higher corporation and other taxes and a stricter anti-avoidance regime if the Tories are in fact ousted. Even if that is not the immediate result of this election, it becomes a real possibility in the near term. International investors may decide to reconsider investment into the UK as they assess what may be another very significant change in the political landscape, albeit the weakening pound may offset this.”

Tax planning gets difficult

As the news of the hung parliament was announced, the situation reminded some people of past precedents.

“We had two elections in 1974 and there was a lot of uncertainty then, but I can’t think of anything comparable to the levels of uncertainty right now,” Bull told International Tax Review. “This isn’t just domestic politics because it affects Europe and constitutional questions. It’s unlikely we will see a second referendum on Scottish independence now.”

“What I would like to see in terms of tax is stability and certainty,” said Bull. “It’s difficult enough for business to plan in an uncertain environment, and they deserve to know what their tax framework will be.”

Prime Minister May has made it clear that she intends to stay in office and is seeking the help of the DUP, a Northern Irish party, in getting her agenda through the House of Commons. In the past, the DUP has cut public spending to fund tax cuts in Northern Ireland, where the party’s base voted for Brexit but they were outnumbered by voters wanting to stay in the EU.

With the EU talks just 10 days away, the question of what kind of deal is needed on Brexit is highly relevant. At Tax Research, Richard Murphy argues that the best approach would be “a Norwegian style agreement with us out of membership but working closely with the EU within the Single Market”. Whether this will be on the negotiating table is another matter.

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