The United Kingdom’s exit from the European Union triggered significant changes in its tax and trade relations with EU member states and beyond. One area of particular importance is the role of double tax treaties (DTTs), which are agreements between two countries designed to prevent businesses or individuals from being taxed twice on the same income. Post-Brexit, double tax treaties play a crucial role in maintaining economic stability, ensuring cross-border trade remains viable, and preventing tax avoidance. This article explores the importance of DTTs post-Brexit and how they are used in practice by businesses and individuals.
The Impact of Brexit on Taxation and Trade
Before Brexit, the UK’s tax relationship with EU countries was shaped by EU directives such as the Parent-Subsidiary Directive and the Interest and Royalties Directive. These rules largely eliminated withholding taxes on cross-border payments of dividends, interest, and royalties within the EU, making it easier for businesses to operate across borders. However, after Brexit, the UK is no longer subject to these directives. This has resulted in increased complexity for businesses operating across the UK-EU border, as businesses and individuals must now rely on bilateral double tax treaties to avoid double taxation.
What are Double Tax Treaties?
Double tax treaties are formal agreements between two countries that aim to prevent the same income from being taxed in both jurisdictions. Without these agreements, businesses and individuals operating in more than one country could face double taxation—first in the country where the income is earned and again in the country of residence.
A typical tax treaty provides mechanisms to allocate taxing rights between the two countries involved, determining how income such as dividends, interest, royalties, and salaries should be taxed. In many cases, these treaties either reduce or eliminate the withholding tax rates on cross-border income. They also set out methods for resolving conflicts and clarifying which country has the primary right to tax certain income.
The Importance of Double Tax Treaties Post-Brexit
The UK has an extensive network of over 130 double tax treaties with various countries around the world. These treaties are vital to ensure that UK businesses and individuals can continue to trade and invest internationally without being unfairly taxed in multiple jurisdictions. Without these treaties, the end of EU tax directives would have created significant financial and administrative burdens on companies and individuals, potentially stifling cross-border trade and investment.
Key Benefits of Double Tax Treaties
- Elimination of Double Taxation:
Double tax treaties are essential for preventing businesses and individuals from being taxed twice on the same income.
- Reduced Withholding Tax Rates:
With the UK no longer benefiting from EU directives that eliminated or reduced withholding taxes on dividends, interest, and royalties, double tax treaties now play a more prominent role in ensuring these taxes remain manageable. DTTs typically reduce withholding tax rates, making it easier and more cost-effective for businesses to engage in cross-border transactions.
- Certainty and Stability:
Brexit has introduced a great deal of uncertainty into international business operations, particularly regarding taxation. Double tax treaties provide a framework that businesses and individuals can rely on to understand their tax liabilities and obligations. This certainty is crucial for long-term planning and investment decisions.
- Dispute Resolution Mechanisms:
Double tax treaties usually include provisions for mutual agreement procedures (MAPs), which allow tax authorities in both countries to resolve disputes over taxing rights. This is particularly important in the post-Brexit landscape, where the risk of conflicts between tax authorities may increase due to diverging national laws and regulations.
How Double Tax Treaties are Used in Practice
In practice, double tax treaties are employed by businesses, individuals, and tax authorities in a variety of ways to minimize tax liabilities and avoid double taxation.
- Cross-Border Business Transactions and Corporate Structuring
For businesses operating in multiple countries, double tax treaties are essential for determining how their income will be taxed. The relevant double tax treaty might reduce or eliminate withholding taxes on dividends and interest, making cross-border transactions more profitable. The availability of favourable DTTs often play a part in structuring decisions.
- Employees Working Internationally
Individuals who work in multiple countries also benefit from DTTs. For example, a UK resident who works in Spain for part of the year could face the risk of being taxed by both the UK and Spanish tax authorities on the same income. However, the UK-Spain double tax treaty would determine which country has the right to tax the individual’s income and may provide relief in the form of a tax credit or exemption in the other country.
- Relief Through Tax Credits or Exemptions
DTTs provide various methods of relief from double taxation, the most common being the credit method and the exemption method. Under the credit method, a company or individual can claim a tax credit in their home country for taxes paid in the other country, ensuring they are not taxed twice. Under the exemption method, income that has been taxed abroad may be exempt from taxation in the home country altogether.
- Claiming Double Taxation Relief
Relief from UK withholding tax covered by a double taxation treaty is not automatic.
The overseas company usually has to apply to HMRC for treaty relief using an online form. This also involves the overseas company obtaining certification of residence from the tax authorities in the country where it is resident.
As part of the claim you can:
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- Apply for relief at source from UK withholding tax on interest, royalties, pensions and purchased annuities
- Claim repayment of UK withholding tax already deducted
You can apply the treaty withholding rate on royalties without making a claim if:
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- your company is located in the UK
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- you reasonably believe that an overseas payee of royalties is entitled to relief under a double taxation arrangement
Conclusion
Post-Brexit, double tax treaties are more important than ever for ensuring that the UK remains a competitive place for international trade and investment. DTTs are essential tools for businesses and individuals navigating the complex tax landscape in the post-Brexit era. Understanding how to effectively use these treaties in practice is crucial for maximizing tax efficiency and avoiding unnecessary costs in international transactions.
