The first is the result of the UK referendum, which was a vote for Britain to leave the EU, and the second is Donald Trump's unexpected victory in the presidential election in the US, which seems likely to bring long-awaited tax reform in its wake. There is a lot of speculation as to what form that might take.
At a time when the after-effects of the financial crisis were still not fully resolved, the introduction of further uncertainty into the UK M&A markets was far from welcome.
No one wants to announce a deal and then find that dramatic external events or developments disrupt that deal whilst it is in the process of closing.
The counterpoint to this, of course, is that the announcement that the UK would leave the EU resulted in a significant fall in the value of sterling – had events in the US followed a more predictable course, this might have been expected to lead to US multinationals in particular bargain hunting in the UK. The fact that it looks as if the pressure to re-invest in order to maintain US tax deferral as regards unremitted low-taxed overseas income might be removed in the future, however, means that we have yet to see many signs of that.
The US election result put the turmoil in Europe in a different perspective – and the elections on the continent later this year may continue, or bring a halt to, the populist process.
The deep pessimism immediately after the referendum result about the economic consequences to the UK of losing its status as the European jurisdiction with a very open economy, a more flexible labour market than many others and a (if not the) world-leading financial centre with guaranteed access to continental Europe seems likely to turn out to have been exaggerated.
There have been some good recent signs of continuing confidence in the UK – not least the decision by McDonald's to locate its non-US IP in the UK and Apple's search for a major headquarters location in the UK (along with one such announcement in the financial sector).
HM Treasury is working very hard to maintain the message that the UK is "open for business" and also to reassure those in the financial sector that the UK will do as much as it can to preserve access to European markets.
Tax is only part of any business decisions to be made here of course – something that has been illustrated by the financial sector's response to entreaties from France to move significant amounts of business there. The labour laws in France are clearly a perceived obstacle and US banks in particular have not made light of that point.
In the tax area, the loss of European treaties seems unlikely to have a major impact. In terms of income flows (dividends, interest and royalties), the UK's extensive double tax treaty network, coupled with the fact that the UK is not itself a withholding tax jurisdiction as regards the payment of dividends, means that any differences are very much at the margin. The fact that the OECD is making moves in relation to the resolution of cross-border tax disputes may take some of the sting out of the loss of full access to the Arbitration Convention. The Merger Directive has not really added much to the corporate reorganisation reliefs already available in the UK.
When UK tax reform started in 2008/2009, the change to a territorial system of taxation (no tax on foreign dividends and much less aggressive CFC rules) could be said to have been driven by cases the UK had lost in the European Court of Justice (ECJ) against taxpayers seeking to protect fundamental freedoms, but HM Treasury and HM Revenue & Customs did not see it in that way. The changes were born of a straight desire to become internationally competitive, which is why the rules were introduced on a global basis rather than just within the EU, so it seems unlikely that any of that will change – and all the signs are that the UK corporate tax rate will continue to be pushed down (so that it may reach a 15% level).
For the moment, however, anyone looking for reasons not to do an M&A deal will find plenty of them.
Looking at the way different companies may now be changing because of the tax situation in the UK:
Although Vodafone announced virtually immediately that it was initiating a review to see whether or not it would be better to be headquartered in the EU (and announced later that it had decided not to make a change), most UK multinationals have remained calm about the situation and satisfied themselves that a UK corporate headquarters is unlikely to be prejudiced by Brexit because income flows into the UK are unlikely to be significantly affected and the position of local subsidiaries operating within the EU should remain unchanged. Provided, therefore, that Brexit is not accompanied by adverse UK tax changes, the expectation would be that multinationals already based here will not want to change their position. They will obviously though keep the position under review.
These fall into two categories:
1) companies that have set up manufacturing operations in the UK and are exporting into Europe; and
2) companies that are either simple regional holding companies or are engaged in UK product distribution.
As indicated by the government's exchanges with Nissan, manufacturers based in the UK are obviously going to be more concerned about the outcome to tariff negotiations than companies from other sectors. An adverse outcome there may have an impact on both existing manufacturing businesses and on decisions to locate new manufacturing bases in the UK (though, as already mentioned, tax is not the only question to be considered in such a decision-making process).
For inbound UK distribution companies, nothing is likely to change – apart from the usual developments as businesses decide how best to distribute their products into any market (i.e. either directly by having people on the ground or remotely through digital sales techniques) with different tax consequences depending on the structure used.
Regional holding companies are again unlikely to be affected – though those looking for a European holding company in the future might have cause to reflect on the relative advantages of the UK and others who offer a similar tax regime. Again, the total package will be what determines the answer to this – the fact that it may be easier to put substance on the ground in one place rather than the other will probably play the biggest role in any decision.
European countries (like Germany) which reacted to the Cadbury case by giving broad CFC exemptions only to subsidiaries based in an EU country (so the analysis for UK subsidiaries may change) may have to think again about whether or not that is an appropriate response – particularly if the result is that companies based in their jurisdiction suffer CFC taxation when really they ought not to.
Two things are clear:
1) no one knows what is going to happen; but
2) financial services companies cannot leave it to the last minute to make changes – so many of them are starting to make plans now.
Most of that planning is being done, however, on the basis that the amount of staff moving will be relatively small, sufficient to effectively service an appropriately enhanced 'booking office' with the major infrastructure being left back in the UK. Whether that remains the model will need to be tested once the Brexit negotiations are completed but it clearly makes no sense for major banks operating in the EU to have their back office substance fragmented across a number of jurisdictions and there is apparently no appetite to move the whole of the business presently in the UK to any one place on the continent.
The UK is as conscious as any other EU country of the fact that businesses were mobile. The freedoms meant that it could not effectively put any restriction (other than CGT exit charges, but they would not bite on substantial holdings where the UK has a participation exemption) on a company's ability to move in or out.
That was what gave rise to the realisation that the UK needed to have a competitive tax regime in order to satisfy the businesses it had already and attract others to the UK. The Corporation Tax Road Map issued by the Coalition government in 2010 and by the Conservative government in 2015 provided ample evidence of that.
Thus, regardless of whether or not Brexit was happening, the UK's competitive tax policy was bound to continue. There is no chance of the UK trying to follow a Singapore model – it does not need to do that. Having that tax policy in place creates a good platform for what may need to be done in response to Brexit.
As regards to M&A activity, US tax changes may mean that inversions no longer happen but the last year has seen Coca-Cola European Partners establish itself in the UK having successfully left the US.
Other activity will depend on market developments but there is no reason to suppose that, in a merger, the UK would not come out as the superior holding jurisdiction if all other things are equal.
The only potential fly in the ointment is that the government will need to make the stamp duty exemption created by the HSBC ECJ litigation survive Brexit if a merger which results in significant shares going into Euroclear or alternative dispute resolution form is not to result in a significant stamp duty reverse tax (SDRT) season ticket charge.
Quite where US tax reform will end up is a mystery.
The US corporate tax system has been plagued with problems for years. It is a major revenue yielder for the government and so the effects of reform may need to be absorbed elsewhere. At present, pure domestic companies pay a high 35% federal rate, US-based multinationals can generate large amounts of low-taxed cash offshore without CFC problems and inbound investors have been able to gear up to a much greater level than their domestic counterparts. Too many distortions – but each had a special interest group firmly behind it.
Before the election it seemed possible that, if the Democrats could ever do what they wanted to do, they would end up with a system pretty much like the UK's but possibly with a 15% corporate tax rate domestically and deciding whether or not CFC rules were going to be a problem. There might have been a repatriation charge on the huge funds left offshore but that would have been about it. In other words, the US would have been a slightly modified territorial system.
But that would not apparently have yielded much additional tax.
So, now the pressure seems to be on to give favourable consideration to a radical reform (called a destination-based cash flow tax; DBCFT) which would charge tax on imports and exempt exports as well as giving 100% tax relief for capital expenditure.
In blunt terms, this would give an immediate boost to the US economy equal to tax on the US's trading deficit. You can see how it would be presented – a boost to US manufacturing with an exemption for exports and a tax penalty on imports. Also, no relief for interest so further restrictions on "games by foreigners investing in the US".
This may be too attractive an opportunity for the incoming government to ignore – but its consequences for international investors and for US multinationals will take a lot of time to work through. While that happens, US companies may not be as interested in merger or acquisition activity as they have been in recent times – and companies looking at a US acquisition will find that very difficult to price in after-tax terms.
We should know better where we are in a few months but there will be a lot of hard work to be done after that – and the WTO will potentially put a spanner in the works if it sees the DBCFT as an unauthorised border tariff. A US VAT would obviously be much easier – but it is apparently politically unacceptable as a "tax on consumers".
Slaughter and May
Tel: +44 20 7090 5022
Steve Edge qualified with Slaughter and May in 1975 and acts for clients across the full range of the firm's practice.
Steve advises on the tax aspects of private and public mergers, acquisitions, disposals and joint ventures and on business and transaction structuring (including transfer pricing in all its aspects) more generally. He also advises many banks, insurance companies, hedge funds and others in the financial services sector in a wide range of areas.
Much of Steve's work has multinational cross-border aspects to it and so he is often working closely with other leading international tax advisers around the world.
In recent years, Steve has also been heavily involved in many in-depth tax investigations of specific domestic or international issues including transfer pricing in particular. He therefore has considerable experience of dealing with HMRC at all levels.
Slaughter and May
Tel: +44 20 7090 3953
James has been a tax associate at Slaughter and May since 2008. He advises on all areas of UK tax law and acts for a wide range of clients, including large multinationals, banks, insurers, hedge funds and commodities traders. He has a particularly strong focus on corporate tax and is known for the commercial focus of his advice. James has extensive experience of domestic and cross-border M&A, joint ventures, and corporate finance transactions generally. He also has a diverse tax consultancy practice, covering all areas of taxation from transfer pricing to employee remuneration, and has worked on a number of disputes and settlements with HMRC.