The fallout from the Brexit vote On June 23, 2016 has been swift and dramatic so far.
Political fallout
Prime Minister David Cameron and other political dominoes in the Conservative party fell, in an incredible sequence of events. David Cameron resigned on July 13 after a new Prime Minister, Theresa May, was selected in a tumultuous political process that was close to unbelievable. Cameron had planned to stay on until a vote in October to choose a new PM, but it seemed as if his party could not wait to move him out of 10 Downing Street. For him, the party was over.
Boris Johnson, a strong supporter of Brexit and an American by birth who stated in 2015 that he would renounce his US citizenship and pay a large IRS tax bill, withdrew from the race to replace Cameron after his deputy and campaigner-in-chief, Michael Gove, undercut Johnson’s bid by making his own immediately before nominations closed. One of the “masterminds” of the “Leave” campaign, Gove and the other Leave proponents had promised during the campaign an additional L350m per week for the National Health Service that would be part of the ‘savings” from leaving the EU. The argument that leaving the EU would “save the NHS” was an important part of the appeal of the campaign and large ads to that effect were splashed on the side of the big red buses of the Leave campaign. However, Gove himself left the race for PM within a week after he had declared himself in and reduced his L350M estimate to L100M, after a spate of leaked emails pointed to backstabbing by his supporters against his competitors, all of which (as well as his controversial history) probably contributed to him coming in third in the Conservative Party primary to succeed Cameron.
Johnson was appointed Foreign Secretary by Ms. May, who apparently followed President Obama’s playbook in appointing his chief political opponent, Hillary Clinton, as his Secretary of State. However, Clinton was not a dual national. Although Johnson reportedly paid his US tax bill, he did not actually renounce his US citizenship. We don’t know all the facts but it is possible that he reconsidered remaining an American citizen after being informed that he might be required to mark all of his assets to market and pay US tax under IRC section 877A.
The vote for the next Conservative Party leader between the two remaining candidates for the job was scheduled for early September, but will never take place. The more conservative candidate, Andrea Leadsom, who supported Brexit, quit the race after being forced to apologize to Theresa May for suggesting that being a mother made her a better candidate for the job. She was not the favored candidate and was proving to be a weak campaigner. Although May supported the Remain camp, she also was a strong supporter of immigration restrictions, which was the linchpin of the campaign. Upon taking office, Ms. May promised that “Brexit means Brexit and we’re going to make a success of it.”
Nigel Farage, head of the UK Independence party (UKIP) and one of the chief proponents of Brexit quit his post as head of the party, declaring that his work was done. George Osborne resigned as Chancellor of the Exchequer. He had lost support from his party after supporting the Remain camp and warning of dire financial consequences from a Leave vote, consequences that appear to be slowly coming to pass.
The Conservative leaders who supported the Leave campaign have lost much credibility over it. Obviously, the wealthy elites quickly removed their support for the leaders of the Leave movement, and switched instead to a member of Conservative leadership who did not support that movement. The wealthy in Britain would seem to have much to lose by Brexit. There was a distinct rumbling from the House of Lords that they might move to delay Brexit; however, it is not clear that either the House of Lords or the House of Commons has the authority to do so.
Unfortunately for the Labour Party, it has failed thus far to capitalize on the Conservative debacle. The leader of the Labour Party, Jeremy Corbyn, is currently embattled as he tries to retain control of the Labour Party after giving his lukewarm support to the Remain faction and mostly being disengaged from the big fight. He didn’t seem to care very much. Now he has lost a vote of no confidence by Labour representatives and a number of his top team have resigned. There is a lot of infighting in Labour right now and the outcome is not clear. If the Labour party can recover its footing, it might be able to force a second vote on Brexit, in which the electorate is provided with more accurate information on the consequences, but that is only speculation at this point.
Economic fallout
What is not speculative is that the UK economy is faltering now due to Brexit. In late July the UK Purchasing Managers Index, which closely tracks UK GDP, signaled a contraction in the UK economy at the fastest pace since early 2009, with both output and new orders contracting. London’s economy is perhaps the biggest victim of Brexit, suffering depressed real estate prices and difficulties in the financial sector that has been London’s — and the UK’s brightest economic star. The possibility of falling tax receipts (as predicted by Osbourne), much of which is generated in London, also poses a distinct danger to the health of the British economy. In the longer term, a number of countries and cities in the EU are becoming more engaged in the effort to woo multinationals’ (and particularly US-based multinationals) European hubs from the UK. For example, I have received emails from colleagues in Amsterdam extolling its virtues — excellent infrastructure, high-skilled work force, and “state of the art” legal and tax system. However, many advisors are suggesting that Germany would be a better place to relocate due to its stable government, strong position in the EU, large market, business-favorable climate, strong workforce and multiple city options for international transportation and logistics. Nevertheless, companies should be both patient and cautious in making such a move. Regardless of where they might move, with big changes in law looming, unless the UK announces that it will make EU law the law of the UK upon Brexit, many EU-based companies will likely be compelled by circumstances to move many of their business groups to the continent, at the same time that several European countries could be offering incentives for the business and the employees. It is quite possible that the UK will be replaced as a multinational hub and center of EU finance.
From an international tax perspective, over the past several years, the UK had positioned itself as a holding company destination and gateway to the EU for non-EU-based companies. The UK had the benefit of the EU withholding tax directives for dividends, interest and royalties, as well as a broad tax treaty network with the rest of the world. The UK also doubled down on its strategy of becoming the leading holding company destination by implementing a territorial system for outbound investment in 2014. After Brexit, the EU withholding tax directives may vanish (unless the UK can successfully renegotiate with the EU to keep them in place). The tax treaties will remain in place, but the limitation on benefits and other anti-treaty shopping provisions that will be implemented under the BEPS project may cause UK-resident companies to lose these tax benefits in certain instances (companies should check the tax treaties relevant to them). These tax treaty changes are likely to unfold over the next few years as the result of ongoing developments, including the implementation of the OECD’s multilateral treaty instrument. Similarly, while EU compliance initiatives may fall by the wayside for the UK, such as the Common Consolidated Corporate Tax Base project (which the UK was not going to follow anyway), OECD compliance initiatives such as BEPS and the OECD common reporting standard are not EU-related and will likely go forward. Ultimately, the effects of international tax changes brought on by Brexit will be a mixed bag and the UK will be able to make some adjustments to its tax system in that regard. If its dream of becoming the premier holding company jurisdiction in the world is shattered by Brexit, (as seems likely), it will be trade and not taxes that deliver the most telling blows. For example, President Obama stated that new trade negotiations between the UK and the US would go to the back of the queue.
Closer to home, the possible departures of Scotland and Northern Ireland from the “United” Kingdom also loom as a big threat to the UK as we have known it. These regions have repeatedly stated that they prefer to stay in the EU and have threatened a referendum (in Scotland’s case, a second referendum) to leave the UK. Breaking up the UK would be difficult for England to swallow. This is a dynamic that we predict will play out slowly as the contours of Brexit become clearer. It seems likely that the UK will attempt to triangulate its negotiations with the EU in an effort to assure Scotland and Northern Ireland that they will not be economically disadvantaged by Brexit, while these two potential breakaway regions might push for some kind of dual status within the EU and the UK. It will be interesting to see how that plays out.
Anti-globalization
The similarity of Brexit to Donald Trump’s anti-immigrant and anti-China campaign is a bit mind-numbing, but the swiftness of the result in the UK is even more stunning when compared to the slower US election cycle. However, the Brexit process is now likely to slow down a bit, even before the UK gives formal notice to leave the EU under Article 50 of the Lisbon Treaty, an event which is currently expected to occur in early 2017. It would not be a surprise for that date to slip, even significantly. There is a lot of infrastructure that the UK had ceded to the EU, particularly in the large and complex areas of trade, regulation, and immigration (including movement of employees between the EU and the UK), and the UK government will need to create its own departments, staff them, and provide political direction to them even as EU negotiations are ongoing. The UK and EU are already bickering about who is going to be responsible for the large pensions owed to UK employees of the EU government. There is much to be resolved in the disentangling. The current talk in the UK is that this process is expected to take at least 2 years after the Article 50 election, but clearly it will take longer than that. The announced expectation of early 2019 has already begun to slip into late 2019.
So, given all this, will the UK actually leave the EU? A lot can happen between now and several years from now. The Labour Party could wake up and present the electorate with an alternative plan. Unfortunately, the next parliamentary election is not until 2020 and the Conservative Party (at least those left standing) appears to be firmly in control. It would take a lot to get Prime Minister May to back off of “Brexit means Brexit,” and it has been reported that she does not intend to hold a parliamentary vote on Brexit. It appears that Brexit will go forward, albeit slowly at first.
There is a future for the UK (or maybe only England) post-Brexit, but it won’t be as bright as it was before June 23rd. Anti-globalization is not a successful economic strategy in a connected world. It is difficult to see how Brexit could make things economically better for Britain, which already suffers from a hollowed out manufacturing sector. However, large portions of the UK population do not care because they feel left behind. The only way out is for the British to find a way to share the benefits of globalization with the middle and lower middle economic classes, or to face an increasing risk of political strife and anti-globalization sentiment.
Allen
