Second Time Around: EU Membership for Scotland is More Difficult, Not Less

And so here we are again. A second independence referendum now seems more likely a question of when, and not if. Those of us who fed into the debate in 2014 are already preparing to do so again. And while the issues remain remarkably the same, the context has changed entirely.

I did not involve myself in the politics of the 2014 referendum at all. In part because I genuinely didn’t make up my mind until the month before. However, as I also contributed towards the academic debate surrounding independence I did not want to appear too partisan.

In 2014, Dr. Daniel Kenealy and I wrote a paper in the European Law Journal, considering the issues surrounding an independent Scotland’s prospective European Union membership. We argued that, although Scotland’s continued membership of the European Union would not be automatic, it was highly likely that it would continue without interruption.

However, that was then, and this is now. And while the issue of EU membership is likely to feature heavily in the debate on Scottish independence once again, the context has changed considerably.

Timing

Nicola Sturgeon wants to time a referendum such that it will be held towards the end of the UK’s Brexit negotiations, but before the expiration of the two year time limit. This is, purportedly, so that Scotland can have a “genuine” choice between independence with EU membership, or union without.

However, this makes little sense for a number of reasons.  Much has been made of the length of time these negotiations might take. Such negotiations almost always go down to the wire, and Article 50 TEU allows for the possibility of seemingly-indefinite extension.

A cynic might take the view that the real reason behind the proposed timing is to ensure the referendum takes place before people acclimatise to Brexit and realise that the sky hasn’t actually fallen in. It is notable that the proposed timeframe is far shorter than the SNP felt necessary in 2011 to conduct a campaign that fully explored the issues.

Furthermore, the timing makes even less sense if the object of the referendum is to allow voters a “genuine choice”, because no such choice will exist. Unless the First Minister seriously proposes that a new state could be set up and continued membership of the EU negotiated within the space of a month, Scotland WILL be leaving the EU one way or the other. The choice on offer will be between Brexit inside the union and Brexit outside of the union, with potential for EU membership further down the line. This, of itself, poses a whole host of new issues that did not exist in 2014.

Sincere Co-operation

The position of a territory seceding from a state that itself is seceding from the EU is vastly different from a territory seceding from a fully-fledged Member State. In the latter circumstance, that secession would result in a considerable dislocation in the EU’s single market, which its institutions, and the Member States, would be legally obliged to seek to avoid. As Dr. Kenealy and I argued in 2014

“[t]he need to avoid such a dislocation represents not merely a pragmatic reason for the EU to enter negotiations with Scotland immediately following a ‘Yes’ vote but also a legal reason. Article 4 makes clear that if such negative externalities, as would be created by Scottish expulsion, threaten to compromise the attainment of the EU’s goals, then steps must be taken to avoid them. The task of ensuring that the Single Market does not suffer any sudden, sharp dislocation is one that flows from the Treaties. To allow the EU to stumble, unprepared, into such a scenario by refusing to address the issue of an independent Scotland until Independence Day, would be a violation of the principle of sincere cooperation, bordering on a dereliction of duty by the Commission and the Member States.”

This statement, however, clearly does not apply mutatis mutandis to a post-Brexit scenario. The unavoidable dislocation has already taken place. There is no impending hole in the EU’s single market that the institutions, or the Member States are obliged to seek to avoid.

This does not mean that there is no chance that institutions and Member States will not seek to make and independent Scotland’s transition into the EU as smooth as possible. Certainly, post-Brexit, some within the EU – most notably, Guy Verhofstadt – have made such overtones, seemingly to spite the UK. While a desire to stick-it to the UK among officials may well work to Scotland’s advantage, it doesn’t come close to the EU-wide legal obligation to work co-operatively with a seceding Scotland that previously existed.

Good Will

You wouldn’t have thought it by the end of the campaign, but the first independence referendum actually came about in a spirit of remarkably good will. The SNP, to everyone’s surprise, won a majority in the Scottish Parliament elections with a clear manifesto commitment that an SNP majority in the Scottish Parliament would mean an independence referendum. This, of itself, is at odds with the more equivocal commitment contained within the SNP’s 2016 manifesto.

The year following the referendum, the UK Government and the Scottish Government signed the Edinburgh Agreement, under which the Secretary of State would make an order under s.30 of the Scotland Act 1998 to grant Holyrood the legislative competence to hold a referendum that would “deliver a fair test and a decisive expression of the views of people in Scotland and a result that everyone will respect.”

The present circumstances could hardly contrast more starkly. The First Minister and the Prime Minister appear to be engaged in a game of constitutional “chicken”, and it’s not clear which party, if either, will blink first.

In 2014 I argued, quite sincerely, that from the moment Scotland voted ‘Yes’ its closest ally would be the rest of the United Kingdom. This was not out of some misplaced belief in David Cameron’s (or, more likely, his successor’s) magnanimity; but quite simply because it would be in the UK’s interests. With a similar outlook and so many shared interests, Scotland would likely be a close ally of the UK in the European Council and Council of Ministers, much like Ireland. I have little doubt that the UK Government would have gone to bat for Scotland’s continued membership of the EU. In the present circumstances such good will seems unlikely, and insofar is the EU is concerned, utterly fruitless in any event.

Currency

In 2014 I did not think it was at all likely that Scotland would be compelled to join the Euro. This was not  because I believed that Scotland would inherit the UK’s opt-out, but because the SNP had been explicit in their intention to continue using the Pound Sterling, whether in a formal currency union or not. As Scotland would have not have had an independent currency it would not have been possible for Scotland to join the Euro.

However, having been the Yes campaign’s key weakness in 2014, it is now clear that the “use the Pound, one way or the other” approach is unlikely to be used again. Any plans for independence would likely have to include a plan for an independent currency and central bank. Consequently, the main barrier to Scotland’s being compelled to join the Euro evaporates. All new members of the EU (and make no mistake, Scotland will be a new member) are obliged to eventually join the Euro.

While it is the case that it is possible to contrive to not join, by keeping your currency out of ERM II, as Sweden does, it is unlikely that Scotland would be able to get away with this for too long. The SNP may have to prepare itself to be able to sell the prospect of Scotland using three different currencies within the space of a decade.

Conclusion

The First Minister wishes to present the choice she wishes to put before the Scottish people as between independence within in the EU, or Brexit within the UK. Scotland’s continued membership of the EU was one of the key issues of the 2014 independence referendum, and it is likely that it will be once again. However, while the issues may well be the same, the context is vastly different; and this changed context turns Scotland’s continued membership of the EU from likely in 2014, to nearly impossible in 2019.

Scotland will be leaving the EU. The reality is that the only choice on offer is between Brexit within the UK, or without it. Whether we like it or not, this is the new reality to which Scots voters need to become accustomed, and about which the First Minister needs to be honest. Only then will we have a rational debate about Scotland’s future.

Brexit Opportunities for Combating Tax Avoidance

The left just doesn’t know what it wants from Brexit. Some have accepted Brexit as a fait accompli – and their approach now appears to be limiting the damage. Others appear to be dead-set on overturning the result of last year’s referendum at the earliest opportunity. Both approaches are politically risky. The former is wishy-washy, satisfying neither the hard-core Remainers nor the devout Brexiteers; while the latter smacks of elitism and disrespect for democracy.

While “third way” approaches may have fallen out of favour with the left, there is an alternative – and that is to embrace the opportunities that Brexit brings to tackle many of the grave injustices imposed by EU law.

One of the most notable of these injustices is tax avoidance. While the European Commission may be the latest passenger on the tax-justice bandwagon, the reality is that it’s EU treaties that make tax avoidance so particularly easy in Europe. Consequently, the ECJ has a long history of striking down national laws designed to combat tax avoidance.

The Chancellor’s Autumn Statement revealed that his predecessor’s much touted Diverted Profits Tax (the so-called “Google Tax”) – designed to stop companies from limiting their tax liabilities by shifting profits to low-tax jurisdictions (like Ireland) – hasn’t yet raised a penny in revenue. I recently revealed in an article in the leading tax journal “InterTax” that this is because EU law means the tax will almost never work.

Article 49 of the Treaty on the Functioning of the European Union (TFEU) prohibits restrictions upon freedom of establishment of nationals of Member States in the territory of another Member State including establishment of companies. Article 58 TFEU further prohibits any restrictions on the free movement of capital. National laws, including tax laws, which infringe upon those rights are, in almost all circumstances, not permitted. This has resulted in many laws designed to clampdown on tax avoidance being struck down by the ECJ.

The case of Sandoz concerned a provision designed to prevent the arrangement of loans outside of Austria to avoid paying tax. In his opinion on the case, the Advocate General took the view that “[t]he principle of the free movement of capital was introduced inter alia in order to enable Community nationals to enjoy the most favourable conditions for investing their capital available to them in any of the States which make up the Community.”

The Court agreed with the Advocate General’s position, ruling that the measure “deprives residents of a Member State of the possibility of benefiting from the absence of taxation which may be associated with loans obtained outside the national territory. Accordingly, such a measure is likely to deter such residents from obtaining loans from persons established in other Member States.”

If the very purpose of free movement is to ensure the allocation of resources to their most efficient location, it logically follows that “shopping around” for the most favourable environment for those resources is perfectly lawful.

Of even greater relevance is the decision of the ECJ in Cadbury Schweppes. At issue in the case was the UK’s rules designed to prevent companies from shifting profits to related companies outside of the UK to avoid tax. The Court in Cadbury Schweppes reiterated its earlier judgement in Barbier that “a Community national cannot be deprived of the right to rely on the provisions of the Treaty on the ground that he is profiting from tax advantages which are legally provided by the rules in force in a Member State other than his State of residence.”

In other words, under EU Law the fact that a company shifts its operations to another EU state (such as Ireland or the Netherlands) to take advantage of more favourable tax treatment cannot be prohibited. Anti-avoidance rules may not be applied, even where there is an explicit intention to avoid tax, where the taxpayer nonetheless carries on genuine economic activities. Anti-avoidance rules, such as George Osborne’s Google Tax, can only work where arrangements are wholly artificial and have tax avoidance as their sole purpose.

And herein lies the problem. The reality is that these arrangements are almost never wholly artificial, with a reduction in their tax bill seemingly being a happy coincidence. At time of writing Google has over 5,000 employees in Ireland, and Apple approximately 4,000. Under EU law any attempts at taxing profits shifted to these jurisdictions is illegal – notwithstanding the fact that they likely would never have located so many employees there but for their 12.5% corporate tax rate.

Freedom from the application of EU rules on free movement of capital and freedom of establishment would allow the UK to enact a genuinely effective anti-avoidance rule. Rather than being limited to a rule that applies only to arrangements the sole purpose of which is to avoid tax, the UK could adopt a rule that clamp down on arrangements which have as their main purpose the minimisation of tax liabilities.

A favourite method of profit shifting by large multinationals is to make royalty and interest payments from subsidiaries in high-tax jurisdictions to subsidiaries in tax havens. A withholding tax on such payments would seriously clamp-down on this prolific method of tax avoidance, but such a tax is prohibited by a 2003 EU Directive.

Combating tax avoidance is just one opportunity presented by Brexit. There are plenty of others.

The left is undoubtedly suffering from an ideological crisis. Many of the left’s assumptions have been challenged by the discovery that its core vote isn’t what it used to be. But if the left decides to embrace Brexit then there are plenty of opportunities. Ending EU-sanctioned tax avoidance would be a good start.

A special deal for Scotland? No chance.

Nicola Sturgeon has accused the UK Government of “ignoring Scotland’s voice” on Brexit. I’m not sure what else the First Minister can expect given that she spent the past six months making demands she knows can never be met. The Scottish Government intervened in Miller on flimsy grounds in the futile hope of securing a veto for Scotland over the UK’s exit from the European Union – knowing full well (as, I think, likely every lawyer in the country did too) that they stood absolutely no chance of success.

Similarly, the First Minister has peddled the myth that it would be possible for some kind of special deal to be struck that would allow Scotland to remain in the EU/EEA/EFTA/single market (these have been used interchangeably). But such a deal is not possible, as I have articulated before. This is for three reasons.

The first, is international law. Scotland is not a sovereign state – it has no legal personality. As Scotland is not an actor in international law, it cannot enter into treaties with other countries. There is no non-independent region in the world (save, possibly, for the Emirates) with the powers that would be necessary to participate in participate in an international organisation like the EEA.

The second hurdle is domestic, and significant. Since early cases such as Costa v ENEL, it has been clear that single market rules are supreme, and rank above all other forms of domestic law. While this wouldn’t pose any problem where Scotland’s devolved competences are concerned, it’s not clear what would happen should single market rules come into conflict with the powers reserved to Westminster. Of course, the UK could devolve those powers necessary for Scotland’s participation in the single market – the trouble is that’s basically all the powers: full fiscal autonomy; regulation of all markets (financial services, energy, telecoms, etc); immigration, naturalisation, and citizenship; competition law; employment law; product standards; consumer protection – to name but a few. Were this to happen, there would be little left of the United Kingdom, save for a currency union and a defence pact. Scotland would be, de facto, independent.

The third problem is EU/EEA law based, and is possibly even more challenging. The EU/EEA’s institutions are designed for independent sovereign states. There is no provision in the treaties for the participation of a non-sovereign territory. Two years ago the worst case scenario was that an independent Scotland would have to follow the EU’s accession procedures set out in Article 49 of the Treaty on European Union. However, when compared to what would be required for a non-independent Scotland to join the EEA the accession process looks like a breeze. Nothing short of substantial changes to the EU and EEA treaties would be necessary to accommodate a non-sovereign Scotland. Even if Scotland could persuade the EU institutions to go along with this, Scotland still comes up against the same brick wall as it would have done post-independence, which is states with their own secessionist movements such as Spain and Belgium. If Scotland gets to participate in the EEA/EU without independence, you can guarantee that Catalonia, the Basque Country, Flanders, and Wallonia (just for starters) will want the same. You can also guarantee that Spain and probably Belgium would veto it – as is their right.

The opposition needs to call out this daft idea for what it is: a complete fabrication designed to stoke the flames of grievance.

It’s clear that the SNP has no interest in securing the “best deal for Scotland” when the only proposals they have thus far made are manifestly impossible. A far more constructive approach would be to lay dibs on the powers being repatriated from Brussels that they believe would be best exercised in Scotland. Agriculture and Fisheries would obviously be top of the wish list. The devolution of labour law and company law would allow Scotland to take a different path from the race to the bottom that the Government in London seems keen to pursue. While absent concerns about compliance with EU law, VAT is one of the best candidates for further fiscal devolution.

If Nicola Sturgeon truly wants the best deal for Scotland she should stop the shadow boxing and start drawing up a wish list that’s actually deliverable.