Are you ready for Brexit?
What companies intending to come to Germany because of Brexit should bear in mind
Even after the decision by the UK Supreme Court in London, the signals are still pointing towards a “hard” Brexit. On 24 January 2017, the highest British court decided to grant Parliament a right to have its say: before the British government can send to Brussels a notification of the intention to exit the EU at the end of March as planned, Parliament has to vote on it.
What happens next?
If a notification of the intention to leave is in fact made at the end of March, the exit process under Article 50 TEU will be triggered. From that moment, the process will take two years, unless the European Council and the UK jointly extend this time limit or there is another exit treaty which provides otherwise. Once this process has been completed, the EU treaties will no longer apply to the UK. The British government also no longer wants the ECJ’s case law to apply to UK cases from that time. In other words, the groundwork will be laid at the latest by the time Article 50 is triggered, and then it will be time to take action. Although the details can and will be decided during the exit negotiations, companies should view the exit notification as an call to take specific steps. There has been a great tendency to speculate about the possible consequences over the past few months. Once the exit process is initiated, companies will have to take appropriate action.
Which companies will be affected by Brexit?
The legal repercussions of Brexit for companies will only become clear during the exit process, and might only be completely settled once the negotiations have come to an end. There may be effects on all companies that have business relationships in the UK or are registered in the UK, whether as a company or a branch office. This means that it is crucial for companies to analyse what risks Brexit entails and how much time is left for a targeted response. Much will depend on whether and to what extent European freedom of movement will continue to be recognised in relation to the UK. Freedom of movement under Article 49 TFEU allows all individuals in the EU to establish their residence in a Member State of the EU. It deals with topics such as setting up and managing undertakings, and is therefore closely associated with the requirement for companies to be treated equally throughout the EU (Article 54 TFEU). The ECJ has repeatedly affirmed these principles in its case law in the past and taken important steps to define the practice of cross-border transfer of corporate seats and the conversion of companies.
What legal forms are affected?
In the wake of Brexit there is once again much talk of the English private limited company (Ltd.) with a German administrative office. Although the formation of UK limited companies has been overtaken by the German “entrepreneurial company” (Unternehmergesellschaft/UG (haftungsbeschränkt)), which also has limited liability, there are still thousands of UK limited companies with administrative office in Germany. If freedom of establishment ceases to apply, however, all companies organised in an English legal form that have a registered office or branch in Germany (or even just business activities) will be affected. The example of the limited liability company, however, serves to illustrate the issue: if freedom of establishment no longer forces other Member States to recognise this legal form, legal entities organised in the English legal form of a limited company will “disappear” from the German register. What is left in Germany is initially often a German civil-law partnership (Gesellschaft bürgerlichen Rechts – GbR) or general commercial partnership (offene Handelsgesellschaft – oHG) whose partners – unlike in the English limited company – are subject to direct and unlimited liability. If there is only one shareholder in the current structure, the German company will expire as a result of Brexit since it is impossible to have a partnership with just one person.
In principle, all English legal forms can be affected: apart from the limited company, the English plc as well as the LP and LLP commonly exist in Germany. Apart from this, there will be a need for action by European companies (SEs) registered in the UK because they will no longer be located in a Member State (EU and EEA).
UK companies and their shareholders affected by this should therefore timely ensure that they find out what possibilities are open to them.
Is your company affected?
If a company is organised in an English legal form and its administrative office or a branch is located in Germany, an alternative solution has to be found if freedom of establishment ceases to apply and no substitute is found. In addition, it is necessary to investigate whether UK companies will have to operate under a German company form due to their business activities in Germany.
What solutions are there?
Until the exit process has been completed, European law with its basic European freedoms and the case law of the ECJ will continue to apply in relation to the UK. Thus the existing statutory instruments can still be used during this period, above all the cross-border merger (codified in Germany in sections 122a et seq. German Reorganisation Act) and on the basis of the ECJ’s VALE decision regarding cross-border conversions of the legal form. Thus a private limited company, or “Ltd.” under English law can be merged with a German limited liability company, or “GmbH”, on a cross-border basis. Partnerships, which are not covered by the statutory scope of application of cross-border mergers, can still at least enter Germany via the route of a cross-border conversion. Both methods have now been tried and tested in practice and, subject to a tax review (see below), are suitable for repatriating German companies. However, it is essential not to lose sight of the time factor in the process. A cross-border merger in particular involves various time limits and waiting periods which can prolong the process. If participation by employees is required, it can be delayed by six months or more.
Other alternatives may exist in individual cases, such as merger by integration or individual legal succession by way of a contribution.
Until the UK actually exits the EU, various directives still apply in the field of direct taxes (Parent-Subsidiary Directive, Interest and Royalties Directive and Merger Directive) which grant a wide range of relief for companies, such as tax-neutral restructuring and relocations of registered offices:
Tax-neutral restructuring: Under the Merger Directive, cross-border restructuring (mergers, divisions, transfers of assets, exchanges of shares) can be carried out involving companies from several EU Member States and transferring the registered office of an SE or SCE to another EU Member State whilst retaining the company’s legal identity, in this case without triggering tax consequences and without revealing the undisclosed reserves at company and shareholder level. After Brexit, these possibilities will no longer be available to companies domiciled in the UK, meaning that any potential transfer to or from the UK should be implemented beforehand. It is likely that cross-border restructuring from the UK could only take place without tax implications if the UK were to join the EEA.
Relocation of companies in Germany: If a company moves away from Germany after Brexit (including the withdrawal of a UK limited company with its management in Germany and the transfer of the registered office of an SE whilst preserving its legal identity), a liquidation tax will be imposed, resulting in a disclosure of all hidden reserves even if a permanent establishment remains in Germany. For this reason, companies should consider moving away sooner rather than later if the UK does not join the EEA.
There will also be major changes in the field of current taxation if Britain leaves the EU:
Distributions of profit by a German subsidiary to a British parent company will no longer benefit from the prohibition of withholding tax (Parent-Subsidiary Directive). There is risk that capital gains tax of at least 5% will be charged under the DTA. Alternative arrangements include Luxembourg-based structures (like those for US investors) or involving a commercial partnership in Germany as an intermediary (but possibly with offsetting).
CFC (controlled foreign company) tax rules: Tax benefits arising from low taxation of passive income at lower levels of the company are corrected. The present protection for EU subsidiaries under section 8 subsection 2 German Corporation Tax Act would cease to apply unless the UK joined the EEA, since UK companies would always be classified as under 25% on average and hence would always be subject to low taxation.
Disputes regarding transfer pricing should be started and settled while the EU Arbitration Convention is still valid since unlike under the alternative agreement procedure, under bilateral treaties the finance authorities involved have to reach an agreement within two years.
VAT: After Brexit the UK will leave the customs union, meaning that the movement of goods to and from the UK will become more complicated and bureaucratic. As far as VAT is concerned, the rules on intra-Community acquisitions and intra-Community deliveries will no longer apply to the movement of goods; these will then be additionally taxed with import sales tax as tax-exempt exports or import deliveries. There are unlikely to be major changes for other deliverables, since services provided to a business are only taxed either in the UK or in Germany in line with the recipient location principle.
What else do companies have to bear in mind?
The repercussions of Brexit on companies will be manifold. Banks in the UK are in the progress of re-examining Germany as a business location from a regulatory and supervisory perspective. The free movement of goods faces major challenges. The issue of secondments will also have to be reexamined in the event of a (hard) Brexit, especially the social security aspects. (See also the article “Die Folgen des Brexit – Was ändert sich im Sozialversicherungs- und Aufenthaltsrecht?” by Angelika Schmid on the Noerr website.)
Britain has the most important European financial centre, and cross-border financing is regularly structured and syndicated from London. Financing agreements or contracts entered into in connection with credit facilities such as hedging transactions can be subject to English law and to the jurisdiction of the English courts. Such choice of law and choice of forum agreements will as a rule continue to be valid after Brexit, meaning that companies who have opted for English law or the jurisdiction of the English courts will unwittingly find themselves in a legal regime that has detached itself from EU standards. Thus the question arises whether new contracts should be made subject to English law in the first place and whether it is possible to refinance existing financing agreements made under English law. Whatever the case, provisions in existing financing agreements which are governed by English law and are directly or indirectly connected to provisions of EU law will have to be scrutinised closely in the future. Companies whose financing partners are domiciled in the United Kingdom will have to wait and see whether these institutions seek to obtain a banking licence in the EU. The regulatory effort this entails could influence how the terms and conditions are structured. Apart from this, lenders who are limited to a certain geographic area when making investments and granting loans (e.g. in the real estate sector) due to the requirements placed on their investments may withdraw their cash and put pressure on prices (e.g. for real estate).
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Any questions? Please feel free to contact: Silvia Sparfeld
Practice Group: Corporate/Mergers & Acquisitions