The consequences of brexit

The UK left the EU VAT regime on 31 December 2020. The UK introduced on 1 January 2021 a deferred import VAT scheme – Postpone VAT Accounting (PVA) – so traders importing goods into the UK do not have to make cash payments of import VAT. This can be recorded through a UK VAT return, which is completed by all UK VAT registered businesses – both UK resident and non-resident.

Cross-border VAT refunds for EU businesses

Most businesses who incur VAT in connection with their activities in an EU country where they do not habitually supply goods/services (and so are not required to register for VAT) are nevertheless entitled to deduct that VAT (Articles 170-171a VAT Directive). This ‘deduction’ is made by means of a refund from the EU country where they paid the VAT.

To qualify for a refund under this procedure, during the refund period a business must not have:

• Been based in the refunding EU country or
• Supplied goods or services there – except:
  • Exempted transport & ancillary services (Articles 144, 146, 148, 149, 151, 153, 159 or 160 VAT Directive); or
  • Supplies to customers liable for payment of the related VAT under the reverse-charge mechanism (Articles 194-197 or 199 VAT Directive).

VAT refunds for non-EU businesses

Businesses not based in the European Union who incur VAT in connection with their activities in an EU country where they do not habitually supply goods/services (and so are not required to register for VAT) are entitled to deduct that VAT. This ‘deduction’ is made by means of a refund from the EU country where they paid the VAT.

VAT refunds for non-EU tourists

EU retailers can provide a VAT refund for goods sold to non-EU tourists when exporting them. Specifically, this covers:

• Tourists whose permanent address or habitual residence (as stated in their passport or other recognized identity document) is not in the EU.
• EU nationals living outside the EU (who can prove this with a residence permit or similar).

Conditions

• The tourists must provide proof of residence (e.g. non-EU passport or residence permit).
• The goods must be taken out of the EU within 3 months of being bought. The tourist must provide a stamped VAT refund document proving this.
• The value of the goods bought must be above a certain minimum (set by each EU country).
• Retailers can either refund the VAT directly or use an intermediary. One or other of them may charge a fee, deductible from the refunded VAT amount.

The Covid-19 crisis provides some leeway for policy support to absorb the negative impact of Brexit, but we expect GDP to remain -2% below pre-crisis levels at end-2022. We expect additional spending of around GBP100bn (or 5% of GDP) on (i) infrastructure at the border and (ii) a VAT cut to limit the loss of purchasing power and the rise in inflation starting in H2 2021. However, the renewed strict lockdown until mid-February is expected to keep the UK in recession in Q1 (-5.5% q/q) as the closure of schools for six weeks will cut GDP growth by more than -3pp, while the closure of non-essential shops and the hospitality sector could cost -2.6pp. Hence, we keep our below consensus forecast of +2.5% for GDP growth in 2021, followed by more than +7.0% in 2022. 

The deal is more advantageous than other FTAs as it offers zero tariffs for goods. However, the exit from the Customs Union means additional administrative burden and higher transportation costs. Overall, we expect these non-tariff barriers to increase costs by 5 to 10%. In the case of the US, the UK is negotiating a FTA but for now, the US is treated as a MFN under the WTO schedules. We detail in this report what the new WTO schedule for the UK means sector by sector.

Cross-border VAT refunds for EU businesses

Most businesses who incur VAT in connection with their activities in an EU country where they do not habitually supply goods/services (and so are not required to register for VAT) are nevertheless entitled to deduct that VAT (Articles 170-171a VAT Directive). This ‘deduction’ is made by means of a refund from the EU country where they paid the VAT.

To qualify for a refund under this procedure, during the refund period a business must not have:

• Been based in the refunding EU country or
• Supplied goods or services there – except:
  • Exempted transport & ancillary services (Articles 144, 146, 148, 149, 151, 153, 159 or 160 VAT Directive); or
  • Supplies to customers liable for payment of the related VAT under the reverse-charge mechanism (Articles 194-197 or 199 VAT Directive).

VAT refunds for non-EU businesses
Businesses not based in the European Union who incur VAT in connection with their activities in an EU country where they do not habitually supply goods/services (and so are not required to register for VAT) are entitled to deduct that VAT. This ‘deduction’ is made by means of a refund from the EU country where they paid the VAT.

VAT refunds for non-EU tourists

EU retailers can provide a VAT refund for goods sold to non-EU tourists when exporting them. Specifically, this covers:
• Tourists whose permanent address or habitual residence (as stated in their passport or other recognized identity document) is not in the EU.
• EU nationals living outside the EU (who can prove this with a residence permit or similar).

Conditions

• The tourists must provide proof of residence (e.g. non-EU passport or residence permit).
• The goods must be taken out of the EU within 3 months of being bought. The tourist must provide a stamped VAT refund document proving this.
• The value of the goods bought must be above a certain minimum (set by each EU country).
• Retailers can either refund the VAT directly or use an intermediary. One or other of them may charge a fee, deductible from the refunded VAT amount.
   

The UK has adopted a new WTO tariff schedule. The latter is independent from the EU’s and applies by default on all goods entering the UK from a country with which the UK has signed no trade agreement to this day.

The trade-weighted average MFN tariff on goods entering the UK used to at 5% before January 1st 2021 (when the UK went by the EU schedule). With the new UK schedule, it dropped to 2.8%. Here is the tariff schedule.

By leaving the EU, the UK no longer benefits from the FTAs signed between the EU and third countries. However, the UK has managed to replicate a series of FTAs matching, to a certain extent, those it used to trade under prior to January 1st 2021. Here is the UK trade agreements with non-EU countries.

Passporting will no longer be possible after the end of the transition period. The FCA, working with other UK authorities, has introduced the temporary permissions regime (TPR). The TPR will allow EEA-based firms passporting into the UK to continue operating in the UK within the scope of their current permissions for a limited period, while they seek full FCA authorisation, if required. The deadline for EEA firms to notify the FCA they want to enter the TPR closes on 30 December 2020.

The TPR will enable various EEA funds to continue to be marketed in the UK for a limited period provided the fund manager has notified the FCA before the window for notification closes on 30 December 2020.

In addition, the FCA and other UK authorities have also introduced the financial services contracts regime (FSCR). This will allow EEA passporting firms that do not enter the TPR to wind down their UK business in an orderly fashion.

When passporting ends at the end of the transition period, the extent to which UK firms can continue to provide services to customers in the EEA will be dependent on local law and local regulators’ expectations. The FCA expects UK firms to take the steps available to them to ensure they act consistently with these local laws and expectations. The FCA is clear that firms’ decisions need to be guided by obtaining appropriate outcomes for their customers, wherever they are based.

Firms should also be prepared for any regulatory changes that will come into force. To help firms adapt to some of the new rules the Treasury has given the FCA new powers to make transitional provisions, known as the temporary transitional powers (TTP). Whilst the FCA has applied the TTP on a broad basis, there are some key exceptions where firms will need to comply with the changed requirements from the end of the transition period. Firms should check the implications of these for their business.

Financial services will no longer benefit from passporting right but from equivalence. However, equivalence for 18 months has only been given on derivatives for the moment, the rest of the financial products are still under scrutiny by the European Commission and this process might take more than 6 months. For now, there is a temporary fix until end of March to avoid disruption. The problem with equivalence rights is that the status can be withdrawn at any time by the EU, as it was the case with Switzerland in 2019 on equities. So this is not a stable solution and we expect capital outflows to intensify over the course of 2021 towards other EU capitals.

The importing Party, on importation, shall grant preferential tariff treatment to a product originating in the other Party on the basis of a claim by the importer for preferential tariff treatment. The importer shall be responsible for the correctness of the claim for preferential tariff treatment and for compliance with the requirements. A claim for preferential tariff treatment shall be based on a statement on origin that the product is originating made out by the exporter or the importer’s knowledge that the product is originating.

A statement on origin shall be made out by an exporter of a product on the basis of information demonstrating that the product is originating, including information on the originating status of materials used in the production of the product. The exporter shall be responsible for the correctness of the statement.

The customs authority of the importing country may conduct a verification as to whether a product is originating or whether the other requirements are satisfied. Such verifications may be conducted by means of a request for information from the importer who made the claim for preferential tariff treatment. Authorities may verify if the claim was based on a statement on origin, that statement on origin; and information pertaining to the fulfilment of origin criteria.

In terms of transportation rights, the trucks can cross three EU countries and stop once with the EU instead of three times as it was the case before.

Please see below table:

• Because of the TCA: Goods traded between the UK and the EU are eligible for the preferential tariff treatment. Paperwork proving eligibility is mandatory.
• Because the UK is leaving the European Customs Union: Goods brought into the UK from countries with which the UK is trading under no special agreement will demand the importer to pay a lower tariff on average.
• Because the UK is leaving the European Single Market: Goods sent to a EU country from the UK will need to abide by EU standards, which may now diverge from UK standards.

For now, the UK Goods Schedule is available on the UK government’s website. Later, it shall be published on the WTO database.

For the rule of origin tariffs, most likely WTO will be applied for the sectors that go above the 45% of foreign input limit decided by the agreement with the EU. The list of sectors is available here and an explanation of the new WTO tariffs is available in this report.

Stocks have risen considerably in late 2020 due to stockpiling, even if to a lower extent compared to 2019, partly due to the weakness of domestic demand. However, the rise in stocks is a concern on the future cash flow of UK companies in an environment where we expect payment delays to increase. So indeed WCR financing could become a challenge in the coming months if the lockdown is extended and/or the recovery remains sluggish.  

We expect the BoE to remain on hold with rates until at least 2023, despite inflation being moderately above the 2% target, in line with the Fed and the ECB. QE tapering is likely to start in H2 2022, but until then we expect liquidity to remain at high levels. This is needed for government spending in order to allow sustainable financing costs for the newly issued debt for the future stimulus plan (we expect GBP100bn to be announced in March). These are our forecasts for the UK: