What Brexit Means Down Under

Much to the surprise of experts, governments, and businesses around the world, Britain and Northern Ireland voted to leave the EU in June of 2016. The referendum result shocked not only the UK and the EU, but also the global economy as a whole. Nevertheless, the UK government has been determined to honour the results of the vote, and initiated the Brexit process officially on March 29, 2017, which is set to culminate in the UK’s departure from the EU on March 29, 2019, two years later.

After two years of tense negotiations and internal political wrangling, the UK appears to have made no appreciable progress in establishing the UK’s future economic relationship with the EU, or the rest of the world. As of today, Brexit appears to be progressing toward what was forecast as the worst-case scenario: a no-deal Brexit, in which the UK’s trade relationships would revert to World Trade Organization rules. Such an outcome is predicted to not only devastate the UK’s economy in the short term but may also have significant secondary impacts on its major trading partners around the world.

Why did the UK join the EU at all?

To understand the import of Brexit on a global scale, it’s important to understand the original purpose of the EU. Decades before the EU was formed, the EEC was established by France, West Germany, Italy, and the Benelux countries as a way to economically unite European countries. Close economic and political cooperation was meant to help these countries both to economically recover from World War 2 and to help build long term relationships that would serve to prevent future martial conflicts.

It was this economic community that the UK joined in 1973, after the 1969 resignation of France’s Charles de Gaulle, who had vetoed Britain’s prior attempt to join in the 1960s. When the single market, the EU as we know it today, was formed in 1992, Britain became a part of it by default.

Why Brexit?

Over time, the EU’s influence over its constituent countries grew, even as more and more countries joined. Unlike the EEC, the EU functions as far more than just an economic community, but rather as a loose superstate comprised of 28 countries. The UK government, for its part, found itself torn between the economic advantages of membership, and the vocal opposition of its right-wing voters even since before it ever joined the EEC.

Before it ever considered joining, the UK had planned to reestablish its status as an economic superpower by developing its own Commonwealth trading bloc. For many British voters, joining the EEC, and later being part of the EU was perceived as a humiliation for a country that had, at one point, governed nearly one-fourth of the world’s landmass. Capitalising on this, British politicians have, whenever possible, laid blame for the country’s economic failures on the EU as a whole, while doing their best to claim credit for British successes nationally. As a result, a large portion of UK voters had little or no concept of how the EU-UK relationship actually works, or how it helped the UK. Instead, it has been primarily viewed as a drain on the country’s resources, and an impediment to its success.

The Global Financial Crisis and the Refugee Crisis

Following the financial crisis in 2008, many of Britain’s fears about the bloc seemed to become reality. The economies of Greece, Spain, Italy, and Ireland were in shambles, apparently validating UK prejudices about propping up weaker countries through its contributions to the bloc. At the same time, immigration to the UK increased as other EU citizens, as well as immigrants from outside the EU, flocked to the country in search of work. Under pressure by his own conservative party, which routinely capitalised on vague anti-EU sentiments, Prime Minister David Cameron was forced to agree to hold a referendum on whether the UK should seek to leave the EU or to remain in it, before December of 2017.

Expecting it to offer him a strong pro-European mandate, the Prime Minister went ahead with the referendum in 2016. However, Brexit campaigners, riding a wave of anti-immigrant sentiment following the 2015 refugee crisis, and capitalising on the public’s weak grasp of the EU’s relationship with the UK, won the simple in-out vote 52% to 48%.

The UK’s negotiation nightmare

The UK economy is the second largest in the EU, and its departure represents a serious loss for the bloc. While this does give it some leverage in negotiating post-Brexit trade deals with the EU, the UK has made practically no progress in securing a deal. The reason for this is that Brexit supporters are determined to secure trade terms that are more advantageous for the UK than EU membership was. Effectively, they want to retain all of the benefits of membership, while simply doing away with the associated costs. After all, this was what they had promised their voters.

EU member states, for their part, see little benefit to agreeing to any such relationship. The UK relies on the EU for over half its import goods, and 44 per cent of its export market. This means that future trade complications with the EU could severely damage the UK’s capacity to trade internationally while being merely painful for the EU. Furthermore, the UK is not able to negotiate new trade deals with non-EU countries until after Brexit takes effect, which would force other trading partners to also begin trading with the UK under WTO rules. This could severely impact the UK’s ability to trade competitively until such a time as new trade deals can be made.

This puts Prime Minister Theresa May, and British negotiators in a position where any deal the country can feasibly negotiate will fall far short of what politicians need to satisfy their pro-Brexit constituents. As a result, the country has gone through two years of negotiations with the EU to produce nothing but a single lacklustre draft deal that the British parliament has vociferously rejected.

Most UK businesses have made no preparations

While no clear plans seem to exist for the UK’s economic future, UK politicians appear adamant that a no-deal Brexit will be avoided. As a result, 5 weeks before the final Brexit date, UK businesses are entirely in the dark with regard to how they will be able to continue to operate internationally after March 29. Not knowing what to do, more than half of the country’s businesses have taken no steps of any kind to prepare.

What a no-deal Brexit means in the southern hemisphere

In the southern hemisphere, Brexit manifests primarily as a bureaucratic headache for exporters, as businesses try to work out what existing EU import quotas mean for trade with the UK and the EU after Brexit. Despite this, total trade with the UK is valued respectively at 1 and 2 per cent of GDP for New Zealand and Australia. While slowed growth in the UK might adversely affect some businesses who trade with it, it’s simply not enough to cause larger economic problems.

This doesn’t mean, however, that there is nothing to be wary of going forward. After all, Brexit is just one of a whole list of events that are rattling global financial markets and raising trade barriers around the world.

Global financial markets are vulnerable

The US’ escalating trade war with China has already slowed trade between the two countries noticeably and is making investors increasingly nervous with talks of a recession in the world’s two largest economies. China’s exports in December of 2018 dropped by 4.4 per cent, while imports fell by 7.6 per cent. This, as well as the US’ internal political difficulties, are putting pressure on 5 of the world’s 10 most important financial centres: New York City, London, Hong Kong, Shanghai, and Beijing. These are ranked as the first, second, third, fifth, and eighth largest financial centres in the world respectively.

The growing threat of trade barriers

If the UK fails to secure a deal that would preserve its international trade deals by 29 March 2019, it will automatically revert to trading under WTO rules. With the US and China already imposing major tariffs, this would make the UK the third of the world’s top 5 largest economies to erect significant trade barriers. This will strongly encourage other countries to follow suit, hoping to protect businesses in their own economies. Ultimately, this would make international trade more expensive for all countries, slowing growth and effectively stalling globalisation.

While it will likely have a secondary chilling effect on the world economy, including the economies of Australia and New Zealand, even a no-deal Brexit would be unlikely to cause real damage. In an analysis of Australia’s position in the global economy, the International Monetary Fund (IMF) determined that global conditions might have some negative impact on the country, but would fail to halt its strong growth. While businesses should certainly pay attention to the larger global developments in the coming months, most will remain well protected from any direct Brexit impacts.

Australian Federal Budget Brief – A NZ perspective of what you need to know about the 2017-18 Federal Budget

Some Important Information for Kiwis from Tuesday’s Australian Federal Budget.

On Tuesday 9th May, the Australian Federal Government released its latest budget. It was an attempt to squeeze more blood out of a stone and to try to balance its books.
Kiwi’s seem to have recently borne the brunt of the Australian Government’s attempts to balance its books with the removal of subsidised Australian university education as an example. The budget yesterday takes this a few more steps further and there are a couple of very important points that our clients need to be aware of:

1. Depreciation restrictions – it is proposed that for properties acquired subsequent to the budget, it will no longer be possible to depreciate plant and equipment apportioned out of the purchase price i.e. chattel split out. Previously there has been an ability to apportion out a part of the purchase price for a commercial property or commercial residential property and claim depreciation on the chattels at higher depreciation rates than building rates. In New Zealand, we continue to be able to depreciate these even though we cannot claim building depreciation.

Existing properties in Australia will be grandfathered. In future where a building is acquired, it will no longer be possible to apportion out the property, plant and equipment. However, where a property owner does spend money on these actual capital items, then they will still be entitled to depreciation.

2. Foreign residents and foreign temporary migrants – individuals who are foreign residents or foreign temporary migrants residing in Australia will no longer be eligible for the principal family home exemption from capital gains tax. When New Zealanders enter Australia, they generally enter as foreign temporary migrants (refer our “Tax Free Sunshine” paper on our Covisory website for the full background).
For foreign residents and temporary migrants moving to Australia from today’s date or acquiring a property after this date, they will no longer be eligible for the exemption. Those already in Australia with existing properties will be grandfathered until June 2019. However, it is not clear whether at June 2019 the properties will then be subject to capital gains tax from that point on subject to a valuation or the whole of the gain up to that point in time will fall to be subject to capital gains tax. More details to follow.

Naturally as Kiwi’s enter Australia as foreign temporary migrants, they are effectively permanently temporary. There is no comment yet from the Australian Government about whether New Zealanders will be specifically excluded from the removal of the principal residence exemption.

We will be arranging to have one of our Australian colleagues come to New Zealand in the next few months to run some specific updates for clients that are affected. In the meanwhile, if you are affected by these changes, please do not hesitate to contact us.

Family Business ~ Insight | Base Erosion and Profit Shifting (BEPS)

There has been a lot of talk in the media and in tax circles recently about BEPS proposals internationally.  Basically the problem is that countries do not believe that existing transfer pricing regimes ensure that the correct amount of tax is paid.  One only needs to look at companies like Google, Starbucks and Apple to see the contrived international structures that they use.

However, in our opinion, BEPS is likely to never go anywhere.  The reason for this is simply that countries are not going to collectively sit down and work out how a corporate group’s profit should be divvied up between them and who gets the right to tax what.  Firstly, they do not have territorial authority over profits made in other countries.  Secondly, it ignores the simple political reality that each country will want to take a greater share of the profits and tax them than the others may agree.  For example, developing countries where goods are manufactured will argue that they should receive a greater share of the profits because they actually manufacture the goods, whereas developed countries will argue that they hold the IP and the IP gives rise to the profits.

The real problem underlying all the discussion around where tax should be paid and how much tax should be paid is that the very countries that are whinging and whining about the use of these structures are the very ones that create the opportunities.  The beneficial tax regimes in Ireland, the UK and the USA are there for all taxpayers to use.  Often the governments will put them in place so that they retain the very large companies that they then berate for paying no tax.

In some ways the analogy is of letting a child into a candy shop, not supervising them and simply telling them they should not help themselves to any lollies when all the lids of the jars are taken off and they are all within easy arms reach.  The governments themselves need to look at their rules before they can get concerned about what the companies are actually doing.

Australian Tax Update

One of our Australian CA colleagues, David Pritchard from ESV was visiting us earlier this week. While David was at our offices we organised for a number of our CA clients to come and attend a update session of Australian Tax – During the session David covered briefly the general environment structures etc for doing business in Australia and in more detail a tax update on what is changing and issues arising from these changes as well as a detailed look at tax residency rules including temporary residents.

As a number of you missed out attending we had David provided us with a copy of his presentation and he gave us a brief intro to the presentation.

Australia is currently experiencing significant changes in its tax law and compliance processes. The changes reach across public and private companies as well as individuals. Despite private companies and high net worth individuals continuing to experience scrutiny from regulatory authorities the fall in the corporate tax rate and rising individual rates provide planning opportunities. [Click here to look at the Australian Tax Update presentation]

If you would like to know more please contact either Nigel Smith or David Pritchard to discuss.

Family Business ~ Insight | The 2013 Australian Budget

The Australian treasurer, Wayne Swann, has stated that “Australia is facing the largest write down since the Great Depression”; as a result of which Swann has introduced a series of tax measures in the 2013 Budget. In addition to tax measures the Government will intensify its tax compliance program by allocating AUD$109M over the next 4 years. Some tax measures that may have relevance to New Zealand individuals and entities include the following:

Thin Capitalisation Rules

Thin capitalisation rules will be amended to set new safe harbour thresholds. The limit for debt to equity will be reduced from 5:1 to 3:1, debt to total asset ratio will be reduced from 75% to 60%. Different rules will apply to financial institutions and banks. For outbound investment, the gearing ratio will drop from 120% to 100%., It is proposed that the worldwide gearing test be extended to inbound investors and that the de-minimis threshold of debt reduction will rise from AUD$250,000 to AUD$2,000,000.

If you have business interests in Australia which are debt funded you may be affected by this proposal.

Capital Gains Tax (CGT)

Changes are also proposed to the foreign resident CGT regime. This is to ensure that gains from disposals of Australian real property are appropriately taxed. The “principal asset test” that is used to determine whether an indirect interest in Australian Real Property exists will be amended. This will ensure that the asset cannot be counted more than once in order to dilute the group’s true asset value.

A withholding regime will also be introduced to support the foreign CGT regime. This will be effective from 01 July 2016. A withholding under this regime does not represent a final tax. A withholding of 10% by the purchaser will be required from the disposal of certain Australian taxable property. The purchaser will be required to remit the amount withheld to the ATO.  The same withholding procedure will apply if the asset is held on revenue account. It is proposed that this withholding be applied to assets over AUD$2.5 Mil

If you have taxable Australian property that is subject to Australian CGT you will be affected by this proposal.

Consolidation regime

It is proposed that the existing loophole in the consolidation regime be closed. Consolidated groups will no longer be able to access double deductions by shifting the value of the assets between the various members of the group. Likewise non-residents will not be allowed to “churn” assets between the consolidated groups.

Dividend washing

A loophole that allows “dividend washing” will be closed. This enables shareholders to claim two sets of franking credits on the same parcel of shares. This happens when the shareholder sells the shares ex-dividend and immediately acquires equivalent shares that carry a right to a dividend.  It is proposed that the shareholder will be able to claim franking credits only once.

If you feel that these rules changes are going to have some impact on your business or personal situation please contact Nigel Smith discuss how he can help you respond to these changes.

Australian Tax Focus

DEBT FORGIVENESS

The Australian government has made an announcement in their Federal Budget to amend the Income Tax Assessment Act, whereby deductions for bad debts will be denied between related parties that are not members of the same consolidated group  where the bad debt written off will not be included as part of the debtor’s income.

It is proposed that in such situations the creditor will have a capital loss rather than a deduction for income tax purposes. This situation will arise where for example the creditor is resident in Australia and the debtor is resident in New Zealand. This has not yet been enacted, but once done it will be back dated to 8th of May 2012.

This will add further layer of complexity to the already complex rules. For example, there is already a tax adjustment when a debt is forgiven: the beneficiary of the forgiveness loses (in descending order) tax losses, capital losses, the tax cost of depreciating assets and the cost base of capital assets up to the extent of the amount forgiven. Related parties can currently choose to forego the losses and the tax consequences.

ATO’s COMPLIANCE PROGRAM

ATO’s annual compliance program was released in July 2012. It identifies areas of compliance risk where ATO’s focus will be directed. Namely:

  • Taxation of Financial Arrangements (TOFA):
    • Validity of elections made for the purposes of TOFA
    • Correct application of tax timing methods
  • Profit shifting  between jurisdictions,
    • Transfer pricing and thin capitalisation
    • Entities with significant asset revaluations that may not be able to meet the safe harbour debt values without these revaluations
  •  Corporate restructuring
    • Mergers and acquisitions
    • Complex and unusual financial arrangements
    • Pre-restructuring activities
    • Changes to the effective ownership and control where the result may be deferral or avoidance of taxation
  • Consolidations
    • Inclusion of foreign partnerships in consolidated groups aimed at achieving a deduction of interest  in two jurisdictions
  • Further Audit activity will be in areas of:
    • GST
    • Research & Development