Law on tax consequences of the Brexit

A Brexit Tax Accompanying Act is currently being drafted to protect entrepreneurs, shareholders and Riester savers from the unintended tax consequences of Brexit.

On March 29, 2017, the United Kingdom notified the European Council of its intention to leave the European Union. Under the terms of the EU Treaty, the United Kingdom's membership in the EU will end two years later, on March 29, 2019. Since then, the British and the EU have been struggling to reach a mutually acceptable agreement on their mutual relationship in the post-Brexit period.

Whether such an agreement will be reached is now more than questionable. While the EU can live with the laboriously negotiated agreement, there is no stable majority in the British Parliament for any of the conceivable Brexit variants. Although the majority of MPs from both major British parties are in favor of remaining in the EU or at least a soft exit, neither party leader is known to be a great friend of the EU and is also using the agreement with the EU as a power political pawn in the UK's domestic politics.

If the agreement is approved by the British Parliament after all, the British would continue to be treated as an EU member for a transitional phase despite their departure from the EU, so that little would change for citizens and companies for the time being on March 29, 2019. During this transition phase, both sides could negotiate further details for the more distant future. However, other scenarios are currently much more likely.

This ranges from a hard Brexit without any mutual agreement with the EU to an extension of the two-year negotiation period by unanimous decision of the European Council to a withdrawal from the withdrawal. The door to this last scenario was opened wide by the European Court of Justice (ECJ) in December, when it ruled that the British could also unilaterally withdraw their application to leave without the other EU states having to agree.

At present, however, all signs point to a hard Brexit. This would mean that, in the worst case scenario, the United Kingdom would no longer be treated as an EU member but as a third country for tax purposes from March 29, 2018. If the ongoing negotiations on a withdrawal agreement are successful after all, this would instead be the case after the expiry of the agreed transition period.

Because various tax and financial market regulations provide for more favorable legal consequences for situations in EU/EEA states than for third-country situations, the UK's transition from an EU state to a third country also has negative tax consequences for entrepreneurs and private individuals with economic interests in the UK. For future projects, those affected can make appropriate arrangements and prepare for the fact that the more advantageous rules will no longer apply in the UK. However, under the current legal situation, some situations are also affected in which the taxpayer has already completed all relevant actions in the past and thus Brexit alone would trigger the adverse legal consequences.

However, for political and economic reasons as well as for reasons of the protection of legitimate expectations, negative consequences in such old cases should be avoided. The German Federal Ministry of Finance has therefore drafted an "Act on Tax Accompanying Arrangements for the Withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union" or "Brexit Tax Accompanying Act" for short.

The aim of the law is to preserve the "status quo" in cases where Brexit would trigger an inappropriate legal consequence that may not be compatible with EU law, to grant the affected taxpayers grandfathering and to create legal certainty. Depending on the regulation, this may affect different periods of time.

In addition to the amendments summarized here, the Act also contains necessary adjustments to the German Building Societies Act and the German Pfandbrief Act in order to protect the continued existence of the banks, as well as an editorial adjustment to the German Value Added Tax Act. All regulations come into force on March 29, 2019 and are drafted in such a way that they are independent of the outcome of the negotiations between the EU and the United Kingdom. The changes will therefore take effect in the event of a hard Brexit as well as in the event of a transition period lasting several years.

• Balancing item: The allocation of an asset to a permanent establishment in another EU country leads to a taxable disclosure of hidden reserves. In order to mitigate the tax burden, the company can form an adjustment item in the amount of the taxable hidden reserves, which is to be released evenly over five years. However, the adjustment item must be reversed immediately if the asset leaves the taxing jurisdiction of the EU states. An amendment to the law now stipulates that Brexit alone does not force the reversal of the adjustment item. Even for assets transferred to the UK, the item can continue to be released evenly until the end of the 5-year period, unless another reason forces the early release, such as the asset leaving the company.

• Contribution profit: The German Reorganization Tax Act (Umwandlungssteuergesetz) provides for retroactive taxation of the contribution gain if, following a contribution in kind or an exchange of shares below fair market value, the contributor or the acquiring company is no longer resident in an EU/EEA state. Brexit would therefore trigger the same legal consequences as an active transfer of business assets or a departure to a third country without further action. A corresponding statutory provision is therefore being created under which, for a contributor or an acquiring company that was already resident in the UK prior to Brexit, the UK will continue to be treated as an EU state, provided that no further event triggering the contribution gains taxation occurs. It is also clarified that this exemption only applies to cases in which the contribution in kind or the exchange of shares was already legally effective prior to Brexit. This ensures that Brexit alone does not lead to a retroactive taxation of a contribution gain.

• Withdrawal taxation: The interest-free deferral of the exit taxation of hidden reserves is linked to a change of residence of the shareholder to another EU or EEA state. However, according to the wording of the law, Brexit alone does not lead to a revocation of the deferral. An event detrimental to the deferral can only be triggered by a further act of the shareholder after the Brexit, for example by the gratuitous transfer of company shares to a person resident in the United Kingdom.

  

• Liquidation taxation: According to the explanatory memorandum, Brexit alone will not have any negative consequences for the liquidation taxation of a corporation, which also applies in the event of the transfer of the registered office or management to a non-EU state, so that no amendments to the law are necessary here either. Only the transfer of the registered office or management to another third country after Brexit would trigger liquidation taxation.

• Riester pension: The state subsidy under a Riester contract is subject to certain conditions. If these are not met, the entitlement to further support lapses and the employee must repay the support already granted. Three territorial requirements for certain cases are now being amended so that no disadvantages arise for old cases (see next points).

• Wohn-Riester: In the case of the Wohn-Riester, only properties in an EU state are eligible. For a property in the United Kingdom, the benefit continues to apply if the property was already used for residential purposes before Brexit and the end of any transitional period.

• Capital transfer: After the death of the allowance recipient, the pension assets subsidized with Riester allowances can be transferred to a Riester contract of the spouse if the spouses were not permanently separated at the time of death and had their residence or habitual abode in an EU state. After Brexit, this also applies without time limit to a residence in the United Kingdom.

• Residence: The consequences of harmful use of Riester allowances also arise if the allowance recipient is not domiciled or habitually resident in an EU state and is not (no longer) entitled to the allowance or the contract is in the payout phase. In this case, there is only a protection of legitimate expectations for old cases: The negative consequences are not to occur if the domicile or habitual residence in the UK was established before the date of the Brexit referendum on June 23, 2016, and the Riester contract was also concluded before that date.