Seeking certainty in an uncertain world

The prospect of massive tariffs, 10km tailbacks at ports, costly customs documentation, VAT issues and much more which could arise as a result of Brexit presents a nightmare scenario for many Irish firms which sell into the UK market. Indeed, the great majority of Irish exporters have cut their overseas trading teeth on our neighbouring island and many of them continue to rely on that market for a significant proportion of their sales.

Brexit preparations have generally involved the old military dictum of preparing for the worst while hoping for the best. But it is hard to prepare for the worst when you don’t really know what it looks like.

For example, much of the work in relation to agri-food was based on educated guesswork on what tariffs might be applied. The announcement by the UK government of the tariffs to apply to a range of food and agricultural produce should have brought more clarity but the opposite ended up being the case as it quickly emerged the proposals were quite likely in conflict with WTO rules.

As a result, some companies have begun to explore how they can take action to create some certainty for their trade with the UK and this has centred around establishing a presence in the market. This could be a full manufacturing operation, a sales and distribution operation, a final processing or packaging facility, or any variant of these.

The benefits depend on the precise nature of the company involved, but in many instances involve the simplification of some of the additional administrative burdens imposed by Brexit. For example, there can be an advantage in owning a company in Britain which would be responsible for importing all of your product destined for that market and then selling it onwards to customers there. One large shipment and one customs declaration is definitely preferable to multiple smaller loads.

But the costs and overall administrative burden on the business could outweigh the benefits. This is the assessment which must be made by companies considering such a move.

The challenge is that no two cases are the same. Every company has different issues and they have to talk to their customers and suppliers about them

“The challenge is that no two cases are the same,” says Johnny Hanna, head of tax for KPMG in Northern Ireland. “Every company has different issues and they have to talk to their customers and suppliers about them. For example, many big retailers don’t want borders, they just want to buy local. Sometimes, the decision is taken out of your hands. The customer says they don’t want the risk of delays at borders and tariffs being imposed and they want to manage that risk by switching to a UK supplier. In that instance, the customer might prompt an Irish supplier to consider establishing a UK operation.”

Advises caution

But he still advises caution. “You have to look into the pros and cons and how quickly you can do it. You can probably do it rather quickly as it’s not that difficult a process. All the other detail and complexity in terms of tax and regulations is not that simple, however. There is no shortage of publications and scorecards out there to help companies establish their Brexit readiness. You have to sit down around the table and identify where you are exposed. You have to add up the risk scores and then decide on the response.”

Cost has to be considered as well. “For sure there is a lot of extra cost involved,” Hanna notes. “If the firm is only producing in Dublin, they have to consider the duplication of costs involved in having another corporate entity. There is also a differential in corporation tax rates.”

But there can be cost advantages. “The obvious advantage in Northern Ireland is the cost base and the personal tax regime. We have been seeing a lot of mergers and acquisitions activity as a result. Some companies in the Republic of Ireland have decided that it is a realistic option to acquire an entity or enter into joint ventures or partnerships with firms in Northern Ireland to hedge against the Brexit risk. The Lakeland Dairies merger with LacPatrick is an example of that. Brexit has definitely pushed more M&A activity.”

Simon MacAllister, transaction advisory services partner and Brexit lead for EY Ireland, sees a number of potential advantages for companies establishing a presence in the UK. “It’s one that people should definitely be thinking about,” he says. “But it depends on a number of factors. It’s difficult to say yes or no definitively. First, there is the scale of what you are doing. If you are doing one order every six months to the UK, it is never going to pay off. Even a few orders a month is probably not worth it.”

While tariffs to goods like beef and dairy will apply regardless, there may still be advantages to establishment in terms of reducing friction. “It depends on the nature of what you are selling. If it’s perishable and subject to high tariffs, there could be an advantage to permanent establishment. There might be efficiencies in clearing and there may be VAT advantages as well.”?

Greater control

It would also give the exporting company much greater control of the process. “It is important that the company you are selling to knows how to deal with imports in the new situation. You could end up with your products stuck in Holyhead because your customer or distributor doesn’t know what they are doing. It really comes down to working out the benefits. What are the additional costs in terms of compliance, VAT, having accounts audited locally, additional complexity, corporation tax issues? There are also systems requirements involved in adding a new entity to a group.”

But these are not insurmountable. “People do it all the time,” says MacAllister. “It’s not a Nato exercise but it doesn’t happen overnight and there is an ongoing compliance cost and so on. Then there is the fixed-cost piece in terms of people and so on. A business has to be at a certain scale to warrant it. It’s not something to do purely just in case, you want to be reasonably certain that it will endure.”

If the UK exits without a deal, they will fall out of nearly all their tax treaties and other arrangements such as EU state aid rules and so on

He points to another potential advantage which has not been discussed very often. “If the UK exits without a deal, they will fall out of nearly all their tax treaties and other arrangements such as EU state aid rules and so on. They will probably opt back in to a lot of them but we don’t know which ones. There will also probably be a fiscal stimulus of some form in response to a downturn in the UK economy. Irish firms can position themselves to take advantage of that by establishing there.”

He agrees with Hanna on the cost-base issue. “If Ireland benefits through UK companies moving here as a result of Brexit, that will drive up salary and office costs. That could mean the cost of doing business in Dublin going up as a result of increased demand for people and office space and so on. That opens the question of whether you want to hire people here in Ireland or in Sheffield at a fraction of the cost? If you set up in Leeds, Birmingham, or Manchester, it’s much cheaper than Dublin. There could be regulatory divergence that makes it easier to achieve local compliance by having an entity in the UK.”

PwC Ireland Brexit partner David McGee is a little more cautious. “From an operational point of view, there is a whole load of other things to do before even thinking about setting up an operation in the UK,” he says. “There is still the question of whether it’s going to be a hard or soft or no-deal Brexit. We are not that clear about what the future is going to look like. If the UK becomes a third country, what kind of tariff wall will they put up? Companies would be making a decision with a large number of unknown variables.”

‘Take advice’

McGee’s colleague in PwC, tax partner Colm O’Callaghan also counsels caution. “Companies are proactively looking at it,” he says. “If they are sourcing from the UK and manufacturing in Ireland there may be advantages to establishing a UK entity, but I would advise them not to jump until they have to. If you are sending goods back and forth in different forms, even if you are not paying duties or tariffs there are other costs to be taken into account. But you are talking about a fundamental change to the business model, so you have to take advice.”

I wouldn't advise anyone to rush in. They should wait to see what happens and make sure they're protected from day one

And there are things that can be done, according to McGee. “I wouldn’t advise anyone to rush in,” he says. “They should wait to see what happens and make sure they’re protected from day one. They can build stocks and if they are worried about trading relationships there are things they can do in terms of improving relationships with customers and suppliers. Once they get over the disruptive period they can move on. If there is a transition, it will be 21 months and that gives people time to get ready.”

Deloitte vice-chairman Pádraig Cronin takes somewhat of a contrarian view and points to some continuing realities. “At a very macro level, regardless of what is happening at the moment, when you look at the global economy and how a company can expand, the UK will continue to have a very significant consumer market,” he points out. “If an Irish business has ambitious growth plans. it will always look to the UK. The result of recent UK tax changes has been to incentivise companies to locate in the UK if they want to make money from its consumer market.”

He doesn’t see any reason for this to change. “Leaving aside Brexit, looking forward strategically five years out, companies will have to put down more roots in the UK. The tax rules in future will make it less attractive to do it from here. If you want to exploit the market you are going to need a certain presence there. And the advantages of that presence are considerable. It is a very large market, we share a language and it has adjacency. Irish business will always look towards the UK.”

But there are still complexities to consider. “If you set up a manufacturing firm in the UK, there are things to look at like supply chain and sourcing strategy within the UK rather than in the EU.”

The UK will continue to be an attractive and very important market for Irish business, which is ignored at their peril

And while the tax rate might currently be higher than Ireland’s, Cronin points out that it is still lower than America’s. “People will think more about market diversification after Brexit but the UK will continue to be an attractive and very important market for Irish business, which is ignored at their peril. Thinking strategically, if a company have enough cash on its balance sheet it is much easier to expand into the UK than into the EU. The UK has to be part of any export plan. Of course, companies must diversify markets but if they have their operating model and supply chains right, the UK is a lower risk. It’s much easier to fix a problem if something goes wrong there than in China, for example. In 10 years’ time, the UK will still be a powerhouse consumer market.”

‘Attractive opportunities’

He believes Brexit could drive increased mergers and acquisitions activity. “There could be attractive opportunities for Irish firms to acquire UK companies,” he says. “They could make transformational acquisitions which can help them move through the cycles. These are win-win transactions. The Irish firm doesn’t need a need greenfield start-up and might instead merge with a UK company with a similar culture which has been experiencing some challenges. Culture is always the most important factor in a successful merger. The new company will have a presence in both the EU and the UK. We see opportunities there for well-capitalised Irish companies to acquire UK businesses which have been going through some turbulence.”

And Irish firms are open to such opportunities, according to KPMG corporate finance partner David O’Kelly. “In late 2018, we asked a number of Ireland’s leading M&A executives, both in the Republic and Northern Ireland, for their views on the outlook for M&A activity in 2019, including the impact of Brexit. A significant majority (75 per cent) of respondents believe that a no-deal or hard Brexit will have an adverse or neutral effect on deal activity this year. Interestingly, some respondents noted that there is logic to UK businesses acquiring in Ireland to either meet regulatory requirements or to de-risk their supply chain. Also, the uncertainty created by Brexit across a range of issues may present a window for opportunistic Irish companies to acquire and build their presence in the UK market.”

Johnny Hanna adds that companies need to be aware of all of the implications before making such a decision. “There are lots of different scenarios. Certainly, some companies are looking at acquisitions or setting up new operations. Many others are just waiting, lighting the candles and hoping for the best. I wouldn’t underestimate the challenges involved in big strategic decisions to set up in another jurisdiction.”

The consensus seems to be that if the move is right for the business it should be made, but it should not be predicated purely on Brexit. Wise advice indeed, considering the continued lack of clarity surrounding the issue.