Originally posted on Business Post 22 November 2020.
The incessant “will they, won't they” speculation over a deal between the EU and the UK is distracting attention from the business disruption that we do know for sure will happen on January 1, 2021.
Even though hopes of a free trade agreement, however limited, are fragile, such an agreement was only ever going to mitigate rather than eliminate the upheaval caused by Brexit.
The principal focus of any free trade agreement is the movement of goods, but more than that is at stake. From January 1, there will be restrictions on the movement of people between the UK and the EU. This, thankfully, will be among the least of the problems encountered by people on this island due to the common travel agreement which pre-dates the accession of either country to the EU.
The situation for goods movement is equally clear-cut, but a lot more dismal. Free trade agreements deal with customs duties and quotas on goods being imported and exported, but tariffs are not the only taxes levied on cross-border trade. Vat is a truly European tax established by an EU directive which all member countries must follow.
Having a Vat system is a condition of membership of the EU. While individual countries are permitted derogations and some flexibility from Brussels‘ rules, such as reduced rates of Vat for the hospitality sector, by and large the rules are rigid.
Vat treatment differs between goods traded within the EU and goods traded outside the EU. From January 1, the Vat system will make no distinction between goods imported from Britain and goods imported from Brazil. While this will affect all importers and exporters on this island, trade deal or no trade deal, the changes will be felt especially in the North.
There should be no doubt in anyone's mind that doing business in and with the North will be a lot harder after January 1 than it is today. Under the Northern Ireland protocol, the region will operate the EU Vat system for goods but not for services, while still applying UK rates for both. This particular fudge has been necessary to ensure no hard border is needed on the island of Ireland to police goods moving North and South. As with all fudges, the arrangement solves one problem but creates others.
In practice it will be impossible to police the tax charge on goods moving between Britain and the North if their ultimate destination is somewhere in the EU. Vat is charged on the value of goods together with any customs duty which has been paid on them. In short, without knowing what the customs duty should have been, the correct Vat cannot be charged. Without a free trade agreement which reduces tariffs between the EU and the UK to nil in most cases, the Northern Ireland protocol cannot work in practice.
There will be additional problems for UK groups with branches in the North. Group companies can be treated as a single entity for Vat purposes but from January 1 next, Northern Ireland companies in a UK Vat group must be treated as separate entities with their own Vat bills and responsibilities where goods move into that company from Britain.
Separately, smaller businesses in particular will feel the loss of a pragmatic margin arrangement for dealing with Vat on second-hand goods which will lapse in the North after January 1.This will present real difficulties for businesses such as car dealerships which routinely pay their Vat on the profit margin, rather than working through the Vat ins and outs and timings of when cars are bought and sold.
We have become accustomed to Brexit threats being batted away or postponed by political wishful thinking. Vat problems will not evaporate in this fashion, because governments are so dependent on Vat revenues. Vat is the largest amount of tax paid in Northern Ireland, some £3.4 billion according to official estimates for last year. In comparison, £2.8 billion was collected in income tax.
Last week there were straws in the wind suggesting that EU compensation schemes might be available for regions particularly badly affected by Brexit. While some Northern Ireland interests are already addressed via the protocol to the withdrawal agreement, it is far from clear that there will be any special arrangements forthcoming from Brussels for a former region which is no longer a member of the European Union.
Time and again, a successful trade deal has been held out as a solution to the worst commercial challenges of Brexit. No trade deal can resolve the additional costs associated with dealing with businesses outside the EU Vat system. Like tariffs, Vat is a protectionist tax. Unlike tariffs, Vat will not be magicked away by any trade deal, even if there is one.
Dr Brian Keegan is Director of Public Policy at Chartered Accountants Ireland