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Potential impact of Brexit on the law firm market

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With Brexit negotiations continuing in the United Kingdom (UK), there is little clarity as of yet on how businesses will be able to operate both in mainland Europe and cross border once the UK leaves the European Union (EU) in March 2019.

As a regulated profession, law firms potentially face greater uncertainty — the regulations directed by each individual bar association must be carefully considered in conjunction with any agreement reached between the UK and the EU.

What’s happening at present in law firms with UK offices?

Brexit remains high on law firms’ agendas, particularly with respect to the uncertainty surrounding firms being able to provide legal services as normal after March 2019. Conversations around restructuring have been brought to the forefront.

Many law firms, UK-headquartered firms in particular, are approaching their final accounting period of trading before the two year Article 50 process expires in March 2019. For some businesses, it is therefore impractical to wait to see how Brexit negotiations progress and how local countries’ bar associations respond. Any action is likely to take a period of time and require HMRC (and potentially other) clearance or clarification.

What should your law firms be doing?

Each business will need to consider its current legal structure, the tax and regulatory rules (including around management, control and profit sharing) in the locations in which it operates, and the profitability of the local offices.

Some firms will wish to restructure, and those most likely to consider restructuring may have:

  • EU operations held within a UK incorporated entity (i.e. an EU branch of UK LLP);
  • EU operations held within a non-UK incorporated entity (i.e. an EU branch of US LLP); and/or,
  • EU incorporated entities with UK solicitors having a level of management and control.

Despite Brexit primarily affecting UK businesses, it is important to note the impact that this may have on US-headquartered law firms. As a result of current regulations, US-headquartered law firms usually operate as a UK LLP, or a branch of the US LLP depending on the EU country in question. However, a by-product of Brexit could see the harmonization of regulation across EU territories so it is possible that neither of these structures will be permissible post-March 2019.

While not certain, to the extent that any grandfathering provisions are introduced there may be benefits in a firm being established in the appropriate country(ies) in the appropriate form before March 2019.

It should be noted that it is possible that a firm may wish to restructure twice: the first time to satisfy the applicable regulations during an interim period to ensure continuity of operations, and once again after a final agreement has been ratified to give a more permanent solution. As we approach the March 2019 deadline there is likely to be an increasing need to have plans in place to manage the uncertainty and satisfy stakeholders.

Potential tax consequences of restructuring?

PwC UK has noted that firms currently considering restructuring their EU operations may consider transferring their EU book of business into a separate EU legal entity. This could involve a demerger of a business within a UK LLP, which poses a number of UK tax considerations, including:

  • whether there has been a cessation of trade in the UK LLP;
  • for UK income tax purposes, whether this could trigger the closing year and opening year rules of taxation to apply to the equity partners (basis period adjustments). Quantification of overlap profits would be required to understand the funding requirements;
  • a UK capital gains tax event could arise on the equity partners upon transfer of partnership assets to a new legal entity;
  • there may be non-UK income tax consequences, for example if an EU office has to move to an accruals basis of accounting; and/or
  • overseas capital gains tax events may also crystallise on the equity partners.

It is clear that restructuring, if necessary, could result in both “dry” tax charges and an acceleration of tax, which may provide challenges around funding for both the firm and the individual partners.

Brexit negotiators have agreed on a deal

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The United Kingdom and European Union negotiating teams have agreed on a Brexit withdrawal deal which Prime Minister Theresa May will present to her Cabinet on Wednesday.

The UK government confirmed reports that May’s most senior ministers would read the details of the draft agreement on Tuesday evening before a special Cabinet meeting at 2PM on Wednesday.

An agreement between the UK and EU over how to prevent a hard border on the island of Ireland as a result of Brexit was reached during intensive negotiations held on Monday and Tuesday, sources told Advisory Excellence.

Brexit talks had for weeks been at an impasse over the question of how a hard border between Northern Ireland and the Irish Republic could be avoided no matter the outcome of negotiations.

UK and EU negotiators agreed that there would be a UK-wide “backstop” if they fail to negotiate a trade deal that negates the need for border checks on the island of Ireland before the end of the two-year Brexit transition period.

The backstop will take the shape of a UK-wide customs union with the EU, with Northern Ireland sticking to some of the European single market. This would guarantee no border checks between Northern Ireland and the Republic.

However, the backstop is set not to come with a fixed end date, as demanded by pro-Brexit MPs, but with a “review clause” for deciding when it can come to an end.

Brexiteers are concerned that this arrangement will leave the UK trapped in a customs union with the EU for years to come, unable to sign new free-trade deals. The UK would also have to continue following numerous EU rules in areas like the environment, employee protections and state aid.

Jacob Rees-Mogg, the leader of the European Research Group of pro-Brexit Conservative MPs, said the deal amounted to a “failure to deliver on Brexit” and would make a “vassal state” of Britain. His Conservative colleague Boris Johnson, the former foreign secretary, described the draft deal as “unacceptable,” adding, “For the first time in a thousand years, this place, this Parliament will not have a say over the laws that govern this country.”

Labour leader Jeremy Corbyn said his party would “look at the details” of the deal, “but from what we know of the shambolic handling of these negotiations, this is unlikely to be a good deal for the country.”

He added: “Labour has been clear from the beginning that we need a deal to support jobs and the economy — and that guarantees standards and protections. If this deal doesn’t meet our six tests and work for the whole country, then we will vote against it.”

The breakthrough in negotiations means EU leaders might be able to ratify the deal at a summit in Brussels later this month. EU ambassadors are set to meet on Wednesday to discuss the next steps in the Brexit process.

What’s next?

Brexit Secretary Dominic Raab reportedly belongs to a handful of Cabinet Brexiteers who are prepared to resign from the government if the Brexit withdrawal agreement doesn’t meet their demands.

Advisory Excellence reported last month that the Cabinet members Andrea Leadsom, Penny Mordaunt, and Esther McVey were all prepared to resign if May accepted a backstop with no fixed end date.

Leadsom said on Sunday that MPs would not accept a backstop which the UK cannot leave without the EU’s permission. She told the BBC: “I don’t think something that trapped the UK in any arrangement against our will would be sellable to members of Parliament.”

Downing Street understand that ministers could quit their positions over the details of the deal.

However, the prime minister has pressed on despite the high-profile resignations of former ministers like Johnson and David Davis and would be likely to do so again.

The European Research Group of pro-Leave Conservative MPs met following the news. A Tory MP who attended told Advisory Excellence the group was “absolutely shell-shocked” because none of May’s “promises” to it had been kept.

Trade Secretary Liam Fox, Leadsom, and Mordaunt “all campaigned with us for Brexit and need to stop this from ever reaching the Commons,” the MP said.

The biggest challenge facing May will come in the House of Commons’ vote on the deal.

Most Labour MPs are set to vote against it, as well as Conservative MPs from the pro-Brexit and pro-EU wings of the party, and possibly the 10 MPs from the Democratic Unionist Party which props up May’s government.

The DUP’s Nigel Dodds said the party “couldn’t possibly vote for” the deal. Pro-Brexit Conservative MP Iain Duncan Smith said May’s days are numbered as prime minister if she goes ahead with it.

Owen Smith, a champion of the anti-Brexit group Best for Britain, said the deal would leave “the British people worse off, and our country weaker as a whole” and urged May to put it to another referendum.

He added: “It’s not enough for May to secure support for her deal from Cabinet, or even from Parliament. This deal will dictate the course for our country for generations to come, and it must be put to the people for their approval or rejection.”

The leaders of the four main opposition parties, including Corbyn and The Liberal Democrats’ Vince Cable, have jointly written to May demanding a “truly meaningful vote” on the deal.