Brexit and UK Software Companies

I was asked recently for any general advice I might have for information technology companies with their EU base in the UK in the face of Brexit, formulated as “issues” and opportunities.

I replied that:

  • The main issue would be what tariffs might need to be paid. The current tariff rate of 0 is ideal. But depending on what arrangements are made during Brexit negotiations, they might turn out to be 10-15%. That’s an “issue” – it would kill a lot of business models.

  • The main opportunity is to establish a wholly-owned company right now somewhere else in the EU through which EU business may continue to be conducted under current EU rules, no matter what the Brexit outcome.

I was attempting to satisfy the condition “as simple as possible but no simpler” but I appreciate that such advice without background could be seen as trite. Here is some justification.

Martyn Thomas pointed out to me that SW companies doing substantial business in particular parts of the the EU will usually already have local subsidiaries. That is true, and consistent with my view. (Such companies will also already have advisors familiar with the company’s detailed business model and will be less interested in general advice from third parties, so weren’t what I was taking to be the target audience.)

Martyn also pointed me to an interesting note by Timothy Taylor on the practicalities of Brexit http://conversableeconomist.blogspot.de/2016/08/brexit-getting-concrete-about-next-steps.html

Taylor refers to a new book from VoxEU, Brexit Beckons: Thinking Ahead by Leading Economists, at http://voxeu.org/content/brexit-beckons-thinking-ahead-leading-economists . VoxEU.org, http://voxeu.org/pages/about-vox , is the “policy portal” of the pan-European Centre for Economic Policy Research, http://cepr.org . The ebook is available at no cost when you set up an account on the VoxEU portal.

Let me restrict my concern here to suppliers of software systems. Bespoke-software supply can be considered a service, since the largest proportion of the lifetime cost of software is in “maintenance”, the generic term for work performed on the software after formal acceptance by the client (see, for example https://rvs-bi.de/publications/Reports/NERC/costs.html for a simple review from twenty years ago, in which maintenance in this sense was thought by various studies to constitute between 60% and 90% of the lifetime cost of bespoke software systems).

Taylor quotes Angus Armstrong from the Brexit Beckons book:

Many [Free Trade Agreements] include service sector provisions, but they typically involve official procurement opportunities, cross-border exports of services (as opposed to locating firms in foreign markets) and transparency agreements, and cover specific sectors only. No FTAs offer anything like the service sector access offered by the Single Market.

Procurements at levels which involve governments often involve strong hidden preference for national suppliers. Almost any bidder for important infrastructure contracts would have to establish a local subsidiary, for three substantial reasons.

First, the “place of business” of local employees is most plausibly where they do the work, and some of that will have to be “on site” in the country where the system will be installed  (let me say henceforth “local”). Business is taxed at the “place of business”, so local tax authorities will require that tax statements are filed, as with any business. Tax-reporting regimes are significantly different in their requirements from country to country and this remains as much so in the EU as elsewhere. Rather than having to file two sets of tax statements each year for the entire company, and do (at least) double the work in your tax preparation, it is much simpler to have a local subsidiary which files taxes related to that project in that country, and file taxes on the rest of your business where you normally do so.

The extra work in filing two sets of returns could be worse than double. For example, Germany requires a specific form of double-entry bookkeeping called Kaufmannisches Rechnen (“businessman’s accounting”) for limited-liability companies. A non-German company doing business in Germany and thus filing German taxes has to engage in Kaufmannisches Rechnen, as well as whatever it uses for its non-German bookkeeping. One might call it diverse dual double-entry. But, unlike software diversity, it is hard to see any functional advantage. And you would need a consistency check across the two bookkeeping modes.

Second, local personnel will have local constraints on employment, social welfare and tax contributions according to local law. These are most easily satisfied through local employment-administration expertise, and thereby a local company structure.

Third, supplier-client contracts will specify dispute-resolution procedures. The client will normally insist that dispute resolution takes place in their local legal system. That system is oriented towards and organised around the legal local company structure. Thus, quite often, a formal contract will only be made with legally local companies.

I see two factors which might most effect post-Brexit software suppliers to the rest-EU. The first concerns procurement. There could possibly be a political lack of will in rest-EU countries to give business to a post-Brexit UK company when there is a local champion which can do the job. Such discrimination could come into play according to whether, during a procurement process, the advisors and negotiators come largely as visitors from the UK, or whether they are local to the procuring country. If negotiating partners are local and live locally, then any business is simply seen as benefitting local employment and business. It’s unlikely anybody except the accountants and lawyers performing due diligence on creditworthiness will worry about ultimate beneficial ownership.

Second, there might possibly be new rules for asset transfer across the EU boundary, not just in the wake of Brexit but also as a consequence of the rest-EU internal economy and a modus operandi for the single currency.

Transfer of assets between a UK company and a wholly-owned rest-EU subsidiary is pretty much seamless at the moment. When the mother company becomes “off shore” to the rest-EU, things may not be at all so straightforward. There are lots of historical examples of significant restrictions on asset transfer across such boundaries; indeed, it is often regarded as one of the tools in the repertoire of national economic policies. Witness sporadic negotiations between Apple and the USG about “repatriating” its profits, most of which are made outside the US and stay there. Some of us remember a time in the 1970’s in the UK when there were strong restrictions on the cash a traveller could take with himher when travelling to other countries. This was said to pose problems for wealthy UK businesspeople resident largely elsewhere, who could not take their money with them. Currently, there are political debates about the within-EU transfer pricing of companies such as Amazon, Starbucks and Google (quite how Apple has escaped such public scrutiny is not clear to me). Some restrictions on transfer pricing across the EU boundary with/to the UK are not inconceivable in an after-Brexit rest-EU continuing to labor under problems with the euro.

All that argues for a UK software company without a rest-EU subsidiary to take the chance to establish one now.

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