Brexit and its tax consequences: We will no longer be treated as equals

08.2019

For some time, experts have been analysing the tax implications of Brexit for the Member States of the European Union. However, one aspect of particular significance from a fiscal standpoint has received little attention so far. The United Kingdom’s withdrawal from the EU means that we will no longer all be equal: British nationals will no longer be treated as EU citizens. This means, above all, that we will cease to regard and treat them as members of the same community—our community, our country, our shared legal and economic space.

Until now, any act or decision emanating from a British public authority—whether judicial or administrative—was recognised in Spain as originating from a “sister” administration, comparable to those issued by a Spanish judge or tax authority. The imperium derived from such acts was almost automatically recognised and respected within our jurisdiction. This mutual respect between British and EU administrations ensured that judgments and administrative acts from the United Kingdom enjoyed a level of authority equivalent to that of our own national authorities, thereby greatly facilitating cross-border business and legal operations.

Brexit changes this framework entirely. From now on, EU Member States will be entitled to question, restrict, or even deny the validity and enforceability of judicial, tax, or administrative documents issued by British authorities. In practice, this will mean that British individuals and companies will face greater administrative burdens when doing business in Spain: more certifications, more guarantees, more official translations, and more verification procedures. Inevitably, this will translate into higher compliance costs and increased bureaucracy. More importantly, from a tax perspective, it will also result in higher taxation.

Over the past twenty-five years, the Court of Justice of the European Union (CJEU) has developed a doctrine—unwritten in the EU Treaties but of immense importance—known as the prohibition of “hidden discrimination”. This principle applies particularly to the field of direct taxation, where, unlike in indirect taxation (such as VAT), there is no EU-level harmonisation. The doctrine prohibits not only openly discriminatory treatment of comparable situations (for example, imposing higher taxes on businesses managed from another Member State), but also any national rule whose practical effect results in a disadvantage for non-residents, even if the law itself appears neutral.

The obligation to treat citizens and businesses of other Member States as if they were domestic is so strong that courts must assess not only the wording of the rule but also its actual consequences. If the practical outcome is unfavourable to a non-resident and no exceptional justification exists—justifications which the CJEU has almost always rejected—the rule must be deemed incompatible with EU law. This case-by-case scrutiny has been instrumental in building the EU’s internal market, comparable to that within a single country.

A simple illustration of this principle can be found in the taxation of property rentals in Spain. Owners of rented real estate are taxed on their net rental income, meaning they may deduct relevant expenses such as depreciation, repairs, improvements, community fees, insurance, and utilities. Initially, this deduction was available only to Spanish tax residents. However, in accordance with EU law, the right to deduct such expenses was later extended to non-residents resident in other EU Member States. Consequently, a UK resident who owned and rented out property in Spain was entitled to the same deductions as a Spanish taxpayer.

Once the United Kingdom leaves the EU, this equal treatment will cease to apply. UK residents will no longer be able to deduct their expenses and will instead be taxed on their gross rental income. Moreover, the applicable tax rate will increase from 19%—the rate applicable to EU residents—to 24%. As a result, a British property owner will pay significantly more tax on the same Spanish property than a French or German resident would.

From now on, British individuals and UK-based companies conducting business in Spain or elsewhere in the EU will be treated in the same way as residents of third countries such as Mexico, Japan, Russia, or Pakistan. And this is just one example. Other areas will also be affected: tax refunds, the costs of corporate restructurings, the resolution of double taxation or residence disputes (which will no longer benefit from the EU’s mutual assistance framework), and the taxation of inheritances and donations involving assets located in Spain, among other situations.

No other international agreement offers investors and taxpayers the same level of protection as the EU’s prohibition of discrimination—both overt and hidden. Article 24 of the Double Taxation Convention between Spain and the United Kingdom, which includes a standard non-discrimination clause found in most such treaties, does not provide the same safeguards. In practice, this clause has rarely been effective, and its practical impact is limited. The only real constraint on Member States’ tax legislation has come from the judicial oversight exercised by the Court of Justice of the European Union.

In conclusion, Brexit brings an end to fiscal equality between British and EU citizens. This fundamental shift demands careful analysis and prudent tax planning to adapt to the new legal framework and to mitigate the significant financial and administrative burdens that will inevitably arise in this post-Brexit tax landscape.

++ Article originally published in German in the magazine “Economía” in May 2019, issued by the German Chamber of Commerce in Spain ++