The British government is preparing for a legal battle with Brussels over EU attempts to force it to increase taxes on commodity derivatives trading, with the UK pledging to fight a move that could hit the City of London’s competitiveness after Brexit.
Officials have told the Financial Times that the Treasury will defend value added tax exemptions that have been challenged by the European Commission on the grounds that they go beyond carve-outs allowed under EU law.
The spat centres on an EU law dating back to the 1970s that gives the UK a right to apply a zero VAT rate to commodities contracts traded on “terminal markets” such as the London Metal Exchange.
The European Commission’s stance is that the exemption has, over the decades, been stretched far wider than was originally intended as markets have evolved, with traders able to escape VAT on commodity options, futures contracts and spot transactions.
But Britain has defended its approach as being in line with EU “standstill” rules that allow the zero rate because it was already in place in the UK before January 1977. Brussels has been at loggerheads with the UK over the issue since March, when the commission first set out its concerns.
In July, it handed the UK a two-month deadline to either bring its national tax rules into line or face being taken to the European Court of Justice in Luxembourg.
Ministers have to respond to the commission by September 19 and are seeking agreement from the government’s inner Brexit war cabinet to defend the status quo at the EU’s highest court.
UK officials said the Treasury believes they can “legally justify the VAT treatment applied to all commodities on these markets” and believes preserving this “popular simplification” for all markets is “vital to ensuring they remain in the UK”.
The disagreement has underlined Brussels’ determination to fully enforce EU law over the UK even as the country prepares to exit the bloc in March 2019.
The move is also a reflection of EU sensitivities about the City having inbuilt advantages over other European financial centres.
Although only months remain before Brexit day, a draft withdrawal agreement being negotiated by the UK and EU would enshrine the commission’s right to pursue such “infringement proceedings” during Britain’s post-Brexit transition period, which runs to the end 2020.
It is not clear at this stage what would happen once the transition period ends as the UK and EU are only in the early stages of defining their future long-term relationship.
A spokesperson for the European Commission told the FT that “the UK has extended the scope of the measure considerably” since it was notified in 1977 “meaning that it is no longer limited to trading in the commodities as originally covered”.
“Under EU rules, this type of ‘standstill’ derogation cannot be extended in scope,” the spokesperson said. “It also generates major distortions of competition to the detriment of other financial markets within the EU.”
One UK official said the planned legal challenge showed that Philip Hammond, the chancellor, was “the one really fighting for the City after Brexit”.