Documents considered by the Committee on 4 July 2018 Contents

6Long-term EU budget 2021–27: possible financial implications for the UK after Brexit

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Exiting the EU Committee, the Treasury Committee and the Public Accounts Committee

Document details

(a) Proposal for a Council Regulation laying down the multiannual financial framework for the years 2021 to 2027; (b) Proposal for a Council Decision on the system of Own Resources of the European Union; (c) Proposal for a Council Regulation laying down implementing measures for the system of Own Resources of the European Union; (d) Proposal for a Council Regulation amending Regulation (EEC, Euratom) No 1553/89 on the definitive uniform arrangements for the collection of own resources accruing from value added tax; (e) Proposal for a Council Regulation on the methods and procedure for making available the Own Resources based on the Common Consolidated Corporate Tax Base, on the European Union Emissions Trading System and on Plastic packaging waste that is not recycled, and on the measures to meet cash requirements

Legal base

(a) Article 312 TFEU; unanimity; (b) Article 311 TFEU; unanimity and national ratification; (c) Article 311 TFEU; QMV; (d)-(e) Article 322(2) TFEU; QMV

Department

Treasury

Document Numbers

(a) (39683), 8354/18, COM(18) 322; (b) (39686), 8357/18, COM(18) 325; (c) (39688), 8359/18, COM(18) 327; (d) (39839), 8360/18, COM(18) 328; (e) (39687), 8358/18, COM(18) 326

Summary and Committee’s conclusions

6.1The issue of contributions to the EU budget was one of the key topics in the referendum that led to the UK’s decision to leave the European Union.

6.2Following the Government’s triggering of Article 50 TEU, the UK and the European Commission provisionally agreed a Brexit financial settlement in December 2017. This stipulated that the UK would pay into the EU budget as if it were still a Member State from March 2019 until 31 December 2020, and contribute afterwards towards the Union’s existing financial commitments that remain outstanding on that day.87 For that same period, there would be a transitional arrangement that effectively keeps the UK in the Customs Union and the Single Market—and therefore bound by EU law—to provide more time for the negotiation and implementation of a new UK-EU free trade agreement. It should be noted that these financial commitments on the UK beyond 29 March 2019 are not presently legally binding; they rely entirely on future ratification of the UK’s Withdrawal Agreement under Article 50.

6.3In May 2018, the European Commission presented its proposal for the EU’s next long-term budget, the Multiannual Financial Framework or MFF, for the period 2021–27. It proposes cumulative EU spending commitments over that period totalling €1.134 trillion (approximately £1 trillion),88 which is only 5 per cent less than expenditure during the current 2014–2020 budgetary period despite the UK’s decision to leave the EU. Under the proposal, which takes the form of a Regulation, EU spending on scientific research, border management, foreign affairs and defence would increase, by reducing agricultural subsidies and cohesion funding for low-income regions in the EU (the two largest areas of the EU budget).

6.4In parallel, the Commission has also proposed a new legal framework governing the Member States’ contributions to the EU budget, the so-called Own Resources Decision (ORD). In addition to increasing the proportion of customs duties collected that Member States must pass to the EU from 80 to 90 per cent, the new ORD would also create three new types of contributions by Member States to the EU budget (based on the corporation tax paid by large companies, revenues from auctions of greenhouse gas allowances, and volumes of unrecycled plastic waste). It would also abolish the UK rebate in light of our withdrawal from the EU. We have set out the substance of both the expenditure and revenue side of the proposed MFF in more detail in “Background” below.

6.5While the UK remains a Member State, the Government has a veto over both the MFF Regulation and the Own Resources Decision, and the latter must also be approved by Act of Parliament under the European Union Act 2011. However, in light of the UK’s decision to leave the EU and the terms of the subsequent financial settlement (see above), the Chief Secretary to the Treasury (Elizabeth Truss) told us in January 2018 that the new MFF would be “not relevant to the UK”, because it “is envisaged to play no part” in that long-term budget.

6.6The Minister submitted an Explanatory Memorandum on the detailed MFF proposals, with some delay, on 18 June 2018. This strikes a slightly different tone, noting that “negotiations on the next Multiannual Financial Framework are primarily a matter for the 27 remaining Member States” but acknowledging that “there are a number of areas where it will be in the UK’s and Europe’s mutual interest to work together on issues relating to the design of the next Framework and its policies and programmes”. That includes, the Minister says, the UK “continuing to take part in those specific [EU] policies and programmes which are greatly to the UK and the EU’s joint advantage”. With respect to the proposals on how the EU budget will be funded from 2021 onwards, the Explanatory Memorandum says these give rise to “limited policy issues” for the UK because “changes to the Own Resources Decision or MFF Regulation which are adopted on or after the date of entry into force of the draft Withdrawal Agreement, shall not apply to the UK in so far as those amendments have an impact on the UK’s financial obligations under the financial settlement” (see paragraph 6.82 in “Background” below).

6.7As we have previously stated,89 we agree that the next MFF is likely to have some financial impact on the UK, the size and scope of which it is difficult to establish at present. We do not accept that it is clear at this stage that the implications of the MFF and the Own Resources Decision are limited to the extent of the UK’s participation in specific EU programmes as a ‘third country’, given the continued uncertainty about the transitional period after Brexit and the precise scope of the ‘backstop’ to keep the Northern Ireland border free of customs and regulatory infrastructure in all circumstances.

UK participation in EU programmes and agencies as a ‘third country’

6.8Firstly, as the Chief Secretary rightly notes, the Government has already announced it will seek to stay involved in various EU programmes and agencies90 following Brexit, such as the 2021–27 Framework Programme for Research and the European Defence Fund.91 Where it can reach agreement with the EU on such participation as a ‘third country’ (which will be especially difficult for any of the regulatory agencies that form part of the institutional architecture of the Single Market),92 it will also necessarily involve a financial contribution. The Government accepts this, but has said repeatedly that such payments should give the UK a “suitable level of influence”.93

6.9In practice, should the UK obtain participation as a ‘third country’, its financial contribution is likely to be linked to the specific costs of the agency or programme to the EU budget and the UK’s economic size relative to the EU’s: therefore, the spending limits in the new MFF, once translated into specific financial allocations in the EU’s annual budgets from 2021 to 2027, will have a direct effect on what the UK contribution might be. In addition, in response to Brexit, the European Commission called for a new ‘automatic correction’ mechanism to any British contributions to specific EU programmes so that the UK cannot become a net beneficiary of the EU budget. Our initial assessment indicates there could be a potential gross UK contribution for participation in EU programmes of approximately £4 billion per year (see paragraphs 6.65 to 6.67).

A partial extension of the transition via the Irish Backstop

6.10Secondly, the Government has proposed that the ‘backstop’ for Northern Ireland—the fall-back option it agreed with the EU in December 2017 to keep the border with Ireland free of customs and regulatory infrastructure through ‘full alignment’ with the necessary EU rules—should be given effect by keeping the UK as a whole in a ‘temporary customs arrangement’ with the EU beyond the end of the post-Brexit transitional period for a “time-limited” (but unspecified) period. Its proposal goes much further than the EU’s customs union with Turkey, the only precedent, because the arrangement would require the (continued) “elimination of tariffs, quotas, rules of origin and customs processes including declarations on all UK-EU trade”.94 The Government also recognised at the same time that an absence of border controls would further necessitate discussions on (alignment with) EU rules on Value Added Tax, excise and regulatory matters such as product standards.

6.11Any such ad hoc extension of the customs-related elements of the transitional arrangement beyond December 2020 for the UK as a whole (rather than, as the EU proposed, for Northern Ireland specifically) could—in addition to facing substantial political and legal hurdles95—involve a financial contribution by the UK towards the EU’s expenditure under the 2021–27 MFF. The exact scope of any such financial mechanism would depend on the substance of the backstop (and in particular whether the customs proposals will be followed by any measures to keep the UK aligned on EU regulatory matters affecting goods as well). In addition, unrelated to the backstop, the Government would also still want to secure uninterrupted participation in ‘flanking’ measures such as the EU’s Framework Programme for Research as described above.

6.12Under such a hypothetical scenario, where border controls were not necessary on any trade in goods between the UK and the EU until a new free trade agreement was in place, the EU might ask the UK to negotiate a financial mechanism covering various different aspects of its continued participation in EU structures. It would of course be up to the Government whether to accept such a proposition or not. Given the state of the negotiations this is necessarily speculative, but such a mechanism could include the following elements for reasons set out in more detail in “Background” below:

6.13In addition, the Government has yet to announce whether it wants to stay in the EU Emissions Trading System after the end of the transitional period. If it does so, the UK might be affected by the Commission proposal to transfer part of the public revenues of emissions auctions to the EU budget (see paragraphs 6.39 to 6.41). There are also of course costs associated with the domestic replication of expenditure in the UK currently handled by the EU, such as agricultural subsidies or regional development funding. We consider those are more appropriately matters for the other Select Committees to consider.

6.14We also considered the hypothetical possibility of a longer ‘full’ transitional period (i.e. on the terms laid down in the draft Withdrawal Agreement, but lasting beyond 31 December 2020).98 This was the Government’s own position as recently as March 2018, when it stated that the transition should last “around two years” (i.e. until the middle of 2021, and therefore into the next MFF period), and was recently referred to again by the Secretary of State for International Trade.99 Our analysis of the possible financial implications of this scenario are set out in more detail in paragraphs 6.70 to 6.84 below.

6.15In summary, if the Withdrawal Agreement were ratified—given none of its provisions, even those agreed at negotiators’ level, are currently legally-binding—and the transitional arrangement it contains were to last into 2021, the UK would likely have to negotiate a specific exclusion from the MFF Regulation and Own Resources Decision to avoid the UK becoming a contributor to the EU budget above and beyond the financial settlement agreed in December 2017. This is also what the Chancellor told us earlier this year, when he explained that “if there were a question about extending the implementation period” that “would be on the basis of a negotiated arrangement about any financial implications of that. It would not be by way of the UK’s adhering to and participating in the next MFF”.100

Conclusions

6.16The uncertainty around the UK’s future economic and security partnership with the EU means it is impossible to determine the exact financial implications of the next Multiannual Financial Framework for the UK.

6.17Under any scenario where the UK remains involved in EU programmes or agencies as a ‘third country’, a financial contribution will be required which will be linked to the EU’s own budget in that area (and therefore to the expenditure limits for different policy areas to be established by means of the MFF). We are disappointed that the Minister’s Explanatory Memorandum fails to provide any meaningful information about the Government’s proposals for a funding mechanism for the EU programmes and agencies in which the UK wants to participate as part of the new UK-EU partnership. Using the EU’s normal methodology for ‘third country’ contributions to the specific Programmes, the gross UK contribution could run into billions of pounds annually.

6.18Moreover, the Government’s high-level proposals for the new economic partnership with the EU envisage a trade agreement which ultimately obviates the need for any border controls on goods moving between the UK and the EU. That is also the objective of its recent outline for the customs-related aspects of the Irish ‘backstop’. In all likelihood, any economic relationship with the EU which is that close is likely to lead to additional requests for financial contributions to the EU (which the Government would, of course, be free to refuse). For example, under the ‘temporary customs arrangements’ the Cabinet Office put forward in June, the UK may have to transfer a share of the customs duties it collects to the EU (potentially under the terms of new EU budgetary legislation, the Own Resources Decision, over which the Government and Parliament will lose their veto101 on 29 March next year). It is also clear from the EU’s economic relations with Switzerland, Iceland and Norway that close integration into even a part of the Single Market is usually accompanied by a request for financial contribution towards the economic development of the EU’s lower-income Member States (although such funding is not paid to the EU, but managed by the contributing and recipient countries bilaterally). We have taken note of the Government’s position that “any final decision on [Cohesion Fund] participation [after 2020] will be taken as part of the discussions on the Future Economic Partnership with the EU”.102

6.19In light of our concerns about the lack of clarity as to the financial implications of both the future partnership and the proposed UK-wide backstop, we have written to the Chief Secretary to the Treasury with a number of additional questions about the Government’s approach on the MFF negotiations. In the absence of further detail about the Government’s position on the cost to the UK taxpayer of its proposals on continued UK involvement in certain areas of EU activity, we will—as a matter of prudence—scrutinise the MFF proposals as having a significant (but unknown) financial impact on the UK taxpayer. As such, we retain the proposed MFF Regulation and the proposals for the EU’s Own Resources under scrutiny, and draw them to the attention of the Exiting the EU, Public Accounts and Treasury Committees.

6.20We now rescind our earlier recommendation for a debate on the 2018 EU budget given that our previous considerations on the Brexit financial settlement have been overtaken by events, but we will consider whether the MFF proposal requires a debate in the House based on any further developments in the negotiations on the UK’s future partnership with the EU and the Government’s upcoming Brexit White Paper.

Full details of the documents

(a) Proposal for a COUNCIL REGULATION laying down the multiannual financial framework for the years 2021 to 2027: (39683), 8354/18, COM(18) 322; (b) Proposal for a Council Decision on the system of Own Resources of the European Union: (39686), 8357/18, COM(18) 325; (c) Proposal for a Council Regulation laying down implementing measures for the system of Own Resources of the European Union: (39688), 8359/18, COM(18) 327; (d) Proposal for a Council Regulation amending Regulation (EEC, Euratom) No 1553/89 on the definitive uniform arrangements for the collection of own resources accruing from value added tax: (39839), 8360/18, COM(18) 328; (e) Proposal for a Council Regulation on the methods and procedure for making available the Own Resources based on the Common Consolidated Corporate Tax Base, on the European Union Emissions Trading System and on Plastic packaging waste that is not recycled, and on the measures to meet cash requirements: (39687), 8358/18, COM(18) 326.

Background

6.21On 2 May 2018, the European Commission presented its proposal for the next long-term EU budget (the ‘Multiannual Financial Framework’ or MFF) for the 2021–27 period.

6.22By means of a Regulation, the MFF will establish the cumulative spending limits for spending in broad areas of policy from the annual EU budgets from 2021 to 2027 (e.g. the heading “Single Market and Innovation”, which includes the Framework Programme for Research, or the heading “Migration and Border Management”, from which the EU’s Border & Coast Guard Agency is funded). Specific multi-annual funding allocations for specific programmes, including the Common Agricultural Policy, will be established in programme-specific Regulations to be negotiated in parallel to the overall MFF limits. The Commission has begun publishing those detailed proposals, which we will scrutinise separately in the coming months to assess their implications for the UK.

6.23The MFF Regulation (and therefore the overall spending limits by which the EU is bound) is subject to the veto of each EU Member State, and requires a vote of approval in the European Parliament.103

EU expenditure from 2021 to 2027: The substance of the proposed MFF

6.24Although the UK’s exit from the EU results in the loss of one of the largest net contributors to the EU budget, the European Commission proposal would nevertheless establish an overall spending limit of €1.134 trillion (£978 billion) over the 2021–27 period, down only slightly from the €1.137 trillion (£975 billion) in the 2014–2020 period (adjusted for inflation).104 As a result, the Commission says the new MFF would be “comparable to the size of the current Financial Framework” but as a share of the EU’s Gross National Income (GNI) it would increase from 1 to 1.11 per cent.

6.25In terms of funding for specific policy areas, the Commission has proposed splitting the previous five main ‘headings’ of the EU budget into seven, with indicative funding allocations over the seven-year period as shown in the table below.

Table 1: MFF 2021–27 (Source: European Commission) 105 106

MFF heading

Proposed 2021–27 MFF limit

In £

Share of total MFF

Increase (real, %) compared to the 2014–20 MFF at EU-27105

1. Single Market, Innovation & Digital

€166 bn

£146 bn

14.7%

+43%

2. Cohesion and Values

€392 bn

£345 bn

34.5%

+1%

3. Natural Resources and Environment, including the CAP

€337 bn

£296 bn

29.7%

-16%

4. Migration and Border Management

€31 bn

£27 bn

2.7%

+210%

5. Security and Defence

€24 bn

£21 bn

2.1%

6. Neighbourhood and the World106

€109 bn

£96 bn

9.6%

+14%

7. Administration

€76 bn

£67 bn

6.7%

+7%

Total

€1.134 trillion

£998 bn

100.00%

+5%

6.26As described by the Chief Secretary to the Treasury in her Explanatory Memorandum on the MFF proposal, even though the overall size of the long-term EU budget would be reduced, the allocations between different policy areas have shifted considerably. The Commission has proposed substantial increases for innovation (including research), border management and security, and external relations. These would be financed by cuts real-term to agricultural subsidies and cohesion funding.107 Nevertheless, agricultural payments and cohesion policy funding would still account for just over half of all EU expenditure. The Committee is assessing the Commission’s funding allocations for individual programmes within the above headings in more detail, and on a case-by-case basis, as part of its scrutiny work in the coming months.

6.27In response to concerns about the deterioration in respect for the rule of law in several EU Member States, the Commission has also tabled a proposal for a new mechanism allowing it to suspend EU budget payments to countries where the sound management of EU money cannot be guaranteed. We have considered this ‘rule of law proposal’ in a separate chapter of this Report.

6.28Given the proposed overall increase in the MFF as a percentage of the EU’s economic size compared to the current long-term budget, combined with the UK’s exit from the EU, the pattern of contributions by the remaining Member States would also change. This resulted in a clear divergence of positions between the net contributors and net beneficiaries of the EU budget at the General Affairs Council meeting on 14 May 2018, exposing fault lines between the countries which want to maintain current levels of expenditure and those who are reluctant to increase their national contributions to make up for the Brexit shortfall. Since then, 6 Member States have already stated their opposition to the proposed cuts to the Common Agricultural Policy. The European Parliament made some initial recommendations for the long-term budget in March 2018,108 and also began formally considering the Commission proposal in mid-May.

The EU’s system of own resources: how the MFF would be funded

6.29In parallel to its proposal to establish the EU’s spending limits for 2021–27, the Commission has also published draft legislation—the so-called Own Resources Decision—on how the EU budget would be funded during that period. Like the MFF Regulation, the Own Resources Decision must be agreed unanimously by all Member States. In addition, as it provides for the transfer of money from national Governments to the EU, it requires ‘approval’ at national level in each Member State of the Union before it can take effect.109 In the UK, under section 7 of the European Union Act 2011, the Government cannot permit an Own Resources Decision to be adopted by the Council unless it is authorised to do so by Act of Parliament.110

6.30The current Own Resources Decision was adopted in 2014 to coincide with the start of the present MFF.111 Under its provisions, which have in substance remained mostly the same since the 1980s,112 the revenue which funds the EU budget consists primarily of its so-called Own Resources.113 This category of revenue can be sub-divided into:

6.31The Own Resources Decision is also the basis for the UK’s budgetary rebate, which effectively gives the Government a veto over its abolition while the UK remains an EU Member State: since any changes require unanimity in the Council, the Government could block any new Own Resources Decision that sought to repeal or modify the abatement, and as a result the existing ORD, including its provisions on the rebate, would remain in effect.

The Commission proposals for new system of own resources

6.32In a policy paper accompanying the 2018 MFF proposals, the European Commission argues that the revenue side of the EU budget should be reformed to decrease its reliance on the GNI-based contribution:

“[The] predominant role of the Gross National Income-based contribution fosters the common perception that EU revenues just reflect the Member States’ capacity to pay and is hence used to justify the focus on net balances and the existence of corrections. The predominant weight of national contributions on overall EU financing fuels the expectation that the EU returns a ‘fair share’ of its spending to each Member State, in proportion to their contributions. This in turn has been identified as one element hampering a more consequential reform of the expenditure side in line with a collective logic of European added value.”117

6.33The Commission therefore also tabled a legislative proposal for reform of the system of Own Resources which would:

6.34Crucially however, the Commission also tabled a separate proposal to introduce three new types of own resources to decrease the EU budget’s reliance on the GNI-based contribution, to “establish the principle that future revenues arising directly from EU policies should flow to the EU budget”.120 These new resources would be:

6.35As new types of own resources, these proposals are likely to face considerable opposition from the Member States and the likelihood that they will all be created is very low. Overall, the Commission proposes to set the Own Resources ceiling—the theoretical amount of total contributions made by Member States towards payments from the EU budget in any one year, at 1.29% of the Union’s GNI (up from 1.23% currently).121 The Chief Secretary’s Memorandum on the Own Resources Decision states only that “limited policy issues arise” because the UK’s financial obligations under the draft Withdrawal Agreement only run until December 2020 and cannot be retrospectively altered by a new ORD (see paragraphs 6.80 to 6.84 below). Nevertheless, given our concerns that the UK payments to the EU after 1 January 2021 may be affected by the new Own Resources Decision depending on policy decisions yet to be made by the Government (see the section on “Potential financial implications for the UK of the 2021–27 MFF“), we have described the new proposed Own Resources individually in more detail.

CCCTB own resource

6.36In 2016, the European Commission re-launched its proposal for a Common Consolidated Corporate Tax Base (CCCTB), which would allow companies with operations in more than one EU country to comply with a single EU-wide set of rules for calculating their taxable income and file one tax return for the entire Union. These consolidated taxable profits would then be shared between the Member States in which the company is active, at the applicable national rate. This apportionment would use a formula to determine what proportion of profits were generated in a specific Member State.122 The Government opposes the proposal, and the House of Commons issued a Reasoned Opinion against the legislation, arguing it breached the subsidiarity principle.

6.37Although the CCCTB proposals remain to be agreed between the Member States, the Commission has now suggested linking the corporate tax raised through the new system to the EU budget. The new corporate tax-base contribution would be calculated by applying a ‘call rate’ on the value of the taxable profits of those companies for which the CCCTB would be compulsory, as apportioned to each Member State.123 The Commission estimates, based on 2012 data, that a ‘call rate’ between 1 and 6 per cent would yield revenue for the EU budget of between €4 billion and €23 billion annually.124

6.38The use of the CCCTB as a basis for an ‘Own Resource’ for the EU budget would require the legislative framework establishing the harmonised EU-wide method of its calculation and consolidation to be in place. At present, it seems unlikely that it will be in place by 1 January 2021, when the new Own Resources Decision would take effect. However, we note that negotiations within the Council on the common rules for the calculation of corporate tax remain live as of summer 2018, with EU Finance Ministers engaging in a high-level policy debate at the ECOFIN Council meeting on 22 June.125 Under the terms of the post-Brexit transitional arrangement, the UK would be required to apply new EU legislation on corporate taxation if it took effect before the end of the transition.

ETS own resource

6.39The Emissions Trading System is one of the main instruments to reduce greenhouse gas emissions in the EU. It sets a cap on the total amount of greenhouse gases that can be emitted by the sectors covered. Companies buy emission allowances to cover their activities (although some industries receive them for free on a transitional basis).126 Most of the auctioned allowances are used by the energy sector.

6.40The Commission has proposed that Member States should pass a share of the revenues generated by their ETS auctions to the EU budget. This new contribution would be calculated using 90 per cent of the allowances distributed to all Member States for auctioning (excluding aviation emissions and the special allowances for the less-developed EU countries).127 However, it would cover the allowances which lower-income EU countries are allowed to use at their discretion to provide to their electricity generation sector for free (so that the new Own Resources Decision would not provide these countries with a perverse incentive to increase the share of free allowances to reduce contributions to the EU budget).128

6.41The auctioning of allowances generated €21.3 billion of revenue for the EU’s Member States from 2013 to 2017 (although that figure includes UK auctions). The Commission estimates that annual average revenue for the EU budget of this new contribution could vary between €1.2 billion and €3 billion, depending on the carbon price and auction volumes. As the Government is yet to announce whether it will seek to remain a full member of the EU ETS even after Brexit,129 it is not clear what this new ‘Own Resource’—if agreed by the remaining Member States—would have for the UK.130 The Chief Secretary’s Explanatory Memorandum is silent on this issue.

Plastic waste own resource

6.42In January 2018, the European Commission adopted an EU Plastics Strategy which set out the EU’s policy options for increasing recycling rates of plastic waste and reducing its leakage into the environment.131 In spring 2018, the Council and Parliament also adopted a new Directive which sets an EU-wide recycling target of 55 per cent for plastic packaging waste by 2030.132

6.43To further incentivise Member States to reduce plastic waste while also generating revenue for the EU budget, the Commission has now proposed to require each EU country to make a contribution proportional to the quantity of plastic waste in their territory that is not recycled (using data on recycling rates that EU law already requires Member States to gather and report).133 In practice, the contribution would consist of a yet-to-be-determined ‘call rate’—up to a maximum of €1 (£0.87)—multiplied by the kilogrammes of non-recycled plastic packaging waste in each Member State.

6.44According to the Commission, the EU (minus the UK) generated 13.6 million tonnes of plastic packaging waste in 2015, of which 40 per cent was recycled.134 As that would impose the new levy on just over 8 million tonnes of unrecycled waste, revenues from this Own Resource would range between €4 and €8 billion (£3.5 to £7 billion) per year (depending on the ‘call rate’ applied, which in this example would range from €0.50 to €1 per kilogramme).

The EU’s revenue under the Commission proposal

6.45The projected amounts of revenue generated under the new system of Own Resources as proposed by the Commission are shown in the table below. As can be seen, despite the UK’s exit the revenue from customs duties would remain roughly constant by increasing the total proportion passed to the EU budget. Conversely, the GNI-based contribution would be reduced substantially by increasing yield from the VAT-based own resource and by means of the new ‘own resources’.

Figure 1: Projected EU revenue 2021–27 (source: European Commission)

Abolition of the UK rebate and other ‘budgetary corrections’

6.46Since 1984, the UK has enjoyed a ‘correction’ to its contributions into the EU budget to reflect the imbalance between payments into the budget and its receipt of EU agricultural subsidies (and given that the UK, at that point, had a lower per capita income than the European Community average).135 This is popularly called the UK rebate.

6.47The UK rebate in turn spawned other rebates and corrections. In particular, since 2002 Austria, Germany, the Netherlands and Sweden have benefited from a reduction in their contribution towards the UK rebate. In addition, reflecting their position as net contributors, Germany, the Netherlands and Sweden currently enjoy a reduced ‘call rate’ for their VAT-based contribution, and Austria, the Netherlands, Sweden and Denmark also receive a lump-sum reduction to Gross National Income-based contributions.

6.48The Commission argues that Brexit offers an opportunity to “render the EU budget more coherent and streamlined” because it renders “the rebates and other correction mechanisms obsolete”. It has proposed to remove all the ‘correction mechanisms’ referred to above, including the UK rebate in view of its exit from the EU. However, to “avoid a significant and sudden increase in the contributions” of the other Member States which have rebates, they would receive lump sum reductions to their GNI-based contribution (which would be gradually phased out by 2025).

Potential financial implications for the UK of the 2021–27 MFF

6.49As a Member State, the UK is a net contributor to the EU budget. From 2014 to 2016, the UK’s average annual share of gross contributions to the budget was just over €17 billion (£15 billion), while its average share of EU expenditure received over the same period amounted to approximately €7 billion (£6 billion) per annum.

6.50The Office for Budget Responsibility have forecast that the UK’s contribution to the 2014–20 Multiannual Financial Framework, including the Brexit financial settlement under which the UK will remain a contributor on its current terms as a Member State until the end of 2020, will amount to 12.4 per cent of all EU spending commitments (marginally lower than the 12.7 per cent estimate previously used by the Treasury). Under the terms of the draft Withdrawal Agreement, if eventually ratified to make it legally-binding, the UK would also pay for a share of the EU’s expenditure commitments still outstanding after December 2020. This means it would contribute towards the ‘payment appropriations’ of the EU annual budget even under the new MFF, but those yearly amounts would decrease over time.136 However, if the transitional period ends on 31 December 2020, the UK would not be legally required to pay towards any new spending commitments made under the proposed 2021–27 financial framework.

6.51Had the UK remained a Member State, with a contributing share of 12.4 per cent, it could have been expected to pay approximately £126 billion towards the 2021–27 MFF expenditure ceilings proposed by the Commission. However, irrespective of the UK’s scheduled withdrawal from the EU, there are two scenarios under which the next MFF and its specific funding programmes remain important for the UK:

6.52We have described the political and financial implications for the UK of both of these scenarios in more detail below.

UK contributions to the EU as a ‘third country’

6.53The first aspect of the 2021–27 MFF’s significance for the UK after Brexit lies in the Government’s stated desire to continue the UK’s participation in specific programmes and agencies funded by the EU budget.

6.54Certain EU funding instruments with a strong cross-border or collaborative element are open to participation by ‘third countries’, in return for a financial contribution and acceptance of the legal framework for the programme as established by the European Parliament and the Council. Formalised cooperation typically requires a specific legal agreement with the EU to be in place, for example the EU-Ukraine Agreement on scientific cooperation or the EU-Switzerland agreement on Swiss participation in the ITER nuclear energy project. As part of its post-Brexit planning, the Government has already expressed an interest in seeking such participation in the 2021–27 successors to current iterations of some specific programmes:

6.55The European Commission proposal for the 2021–27 MFF also cautiously assumes that some form of UK ‘third country’ contribution will take place after Brexit, noting that “external contributions, notably from the United Kingdom, may alleviate the strain on Own Resources” (i.e. the size of the remaining Member States’ contributions to the EU budget).143

Conditions for and restrictions on UK participation in EU programmes as a ‘third country’

6.56The extent to which the current iterations of any relevant EU programmes allow for full participation by ‘third countries’ varies. For example, while the Framework Programme for Research contains a mechanism for ‘association’ by non-EU countries which is widely used, third country participation is not foreseen for the European Development Fund or most of the European Defence Fund. Even during the post-Brexit transition, when the UK remains a full budgetary contributor, the EU can already exclude the UK from certain “sensitive” programmes—including parts of the Galileo satellite navigation project and the European Defence Fund.144

6.57The European Council, in its March 2018 Guidelines on the “future framework”, was clear that any UK participation of this kind would be based on the conditions and restrictions established by the EU as regards ‘third country’ involvement generally:

“Regarding certain Union programmes, e.g. in the fields of research and innovation and of education and culture, any participation of the UK should be subject to the relevant conditions for the participation of third countries to be established in the corresponding programmes.”145

6.58As all EU funding programmes need to be re-established with a new legal framework at the start of each MFF, it is not yet possible to say what the exact conditions for UK participation as a ‘third country’ from 2021 onwards would be for the programmes in which the Government is seeking continued involvement (see paragraph 6.56 above). The programme-specific requirements or restrictions on non-EU involvement will be determined by the Regulations that underpin them (as agreed between the EU Member States and the European Parliament). For the 2021–27 MFF, those discussions will take place in the coming months and years.

6.59While the UK will be able to participate in the Council’s negotiations on the next MFF and the legal frameworks for individual EU funding programmes while it remains a Member State, it is likely to lose its voting rights before any of the proposals are formally agreed between the Council and the European Parliament.146 It will therefore be paramount that the Government secures the best possible ‘third country’ mechanisms in the draft Regulations for Programmes where UK participation is desirable, and this will be an area of focus for the Committee as it scrutinises the programme-specific proposals in the coming months.

The UK’s financial contribution to EU programmes as a ‘third country’

6.60One of the biggest questions about UK involvement in EU programmes as a ‘third country’ will be the requisite financial contribution once it is no longer paying into the EU budget as a Member State, and the formal levels of participation and of influence this brings in return.147 As the Chief Secretary notes in her Explanatory Memorandum, for “any UK participation in policies and programmes in the next MFF”, the Government would “expect to make an ongoing contribution to cover our fair share of the costs involved and the exact terms would be subject to negotiation”. However, she makes no attempt to set out the UK’s proposals for the calculation of that contribution.

6.61Instead, we are left to examine existing precedent. Where EU programmes make provision for participation by non-Member States, the ‘third countries’ in question typically make an annual financial contribution which is calculated based on the EU’s own budget for the programme for any given financial year and the third country’s share of the total GDP of the EU plus the country itself (the so-called ‘proportionality factor’, which for the UK currently stands at approximately 16 per cent).148 This underpins, for example, the mechanism agreed by Norway and Switzerland with the EU to allow for the full participation their researchers in the Framework Programme for Research.149 In practice therefore, the contribution a third country makes is decided largely for them by the EU, as it is the main variable is the contributions the Member States themselves are expected to make as part of the annual EU budget.

6.62In terms of influence over the strategic direction or priorities of EU funding programmes, ‘association’ buys the governments of third countries only limited formal leverage. While their representatives can typically attend the technical committees where EU Member States have to approve work programmes (and sometimes individual funding decisions) put forward by the European Commission, they act as observers only and have no voting rights. The position of the UK Government is that it is willing to make “appropriate” financial contributions to specific EU programmes, but that this should in turn come with a “suitable level of influence” for the UK.150 It has so far refused to define either what “appropriate” means in this context (for example, whether the ‘GDP approach’ as outlined in paragraph 6.63 would be acceptable), or specify what it believes a “suitable” degree of influence would look like in practice (for example, whether that condition is met by being granted the same observer status on the relevant technical committees as other ‘third countries’). As noted, the Treasury’s Explanatory Memorandum on the next MFF provides no further clarity about the Government’s thinking in this regard.

6.63Moreover, the issue of Brexit will also politicise the question of any UK participation and the size of its expected financial contribution. For example, the Commission has proposed what is, in effect, a UK-specific financial contribution mechanism for participation in the next Framework Programme for Research (FP9 or ‘Horizon Europe’). Under its proposal, the UK’s payments would be subject to an “automatic correction of any significant imbalance compared to the amount that entities established in the [UK] receive through participation in the Programme”: in other words, the UK would have to pay more into the Programme than it does at present to ensure it does not remain a net beneficiary when it becomes a ‘third country’.151 Several of the Commission proposals for funding programmes under the 2021–27 MFF, including FP9, Creative Europe and Erasmus+, also explicitly state that the UK, as a third country, cannot have an agreement which “confer[s] a decisional power”, presumably voting rights, within the committees that oversee the European Commission’s management of those programmes.

6.64If the other Member States and the European Parliament accept these proposed parameters, it will severely constrain the Government’s room for manoeuvre in negotiating participation agreements. Whether the EU institutions will seek to modify those provisions to facilitate full participation of the UK in specific programmes in return for a balanced financial contribution will be a major test of the Government’s strength in the negotiations on the future UK-EU partnership.

The potential cost of UK participation as a ‘third country’

6.65Given the uncertainties about which programmes the UK will actually participate in once it is fully a ‘third country’ vis-à-vis the EU, and the substance of the financial mechanisms to underpin such involvement (which may differ on a case-by-case basis), it is impossible to estimate a priori the total annual cost to the UK taxpayer of programme-specific participation. However, by way of example, under the ‘GDP approach’ used to calculate Norway and Switzerland’s participation in the Framework Programme for Research (FP8), the UK’s annual gross contribution to FP9 alone could be €2.3 billion (£2 billion) annually.152

6.66If we assumed for the sake of argument that the UK could obtain participation in all six programmes in which the Government has expressed an interest, using the same calculation of the potential UK contribution based on its GDP and the proposed budget for the 2021–27 period in the Commission’s MFF proposal, we could arrive at an estimate of a gross annual contribution of approximately £4 billion, as shown in the table below.

6.67These estimates are necessarily extremely provisional: in reality, the overall net UK contribution would be different because the EU’s own budget for these Programmes might be different (lower) than proposed by the Commission; the financial mechanism agreed with the EU might use a different methodology to calculate the UK’s contribution (for example, we do not know how the ‘automatic correction’ could operate in practice to balance the UK’s contributions and receipts);153 there would be funding flowing back from these Programmes to the UK; and it is unclear if the Government could secure full participation in all these areas of EU activity as a ‘third country’ (or, conversely, if there are other EU programmes not listed here in which it also wants to participate). It also excludes the possibility of any additional direct UK assistance to the EU’s low-income Member States as described in paragraph 6.70 below.

Table 2: Potential gross UK contribution to select EU programmes, 2021–27 154 155 156

Programme

Proposed average annual EU budget 2021–27

Option for ‘association’ by third countries

Potential gross annual UK contribution if participation permitted 154

Potential gross annual UK contribution in £

Framework Programme for Research (FP9)

€14 bn

Yes

€2.2 bn155

£1.9 bn

Euratom Research Programme

€343 mn

Yes

€55 mn

£48 mn

ITER nuclear fusion project

€867 mn

Yes

€139 mn

£121 mn

EU Space Programme (Galileo & Copernicus)

€229 mn

Partial156

€37 mn

£32 mn

European Defence Fund

€1.86 bn

Unclear, possibly for EEA countries only157

€297 mn

£260 mn

Neighbourhood, Development & International Cooperation Instrument

€12.8 bn

Unclear158

€2 bn

£1.79 bn

Total per annum

€30 bn

-

€4.8 bn

£4.2 bn

Other financial aspects of the future UK-EU partnership 157 158

6.68Beyond programme-specific participation there are also other elements of the future UK-EU economic relationship that could entail a financial contribution from the UK to the EU budget.

6.69We have written to the Chief Secretary to the Treasury to request further information about each of these elements of the future partnership, and their financial implications.

Financial implications of continued participation by the UK in the Single Market or Customs Union beyond December 2020

6.70The second potential scenario under which the next MFF would still be relevant for the UK (and more so, in terms of the likely financial cost) is related to the length of any post-Brexit arrangements that effectively keep the UK in (parts of) the Customs Union or Single Market beyond the scheduled end of the transition on 31 December 2020.163 In such an eventuality, we consider it likely the UK would be asked to make a continued financial contribution commensurate in some way with its participation in EU structures. As we have stated, it would of course be up to the Government to refuse any such proposition if it did not feel it offered sufficient benefits for the UK in return.

6.71In January 2018 the Treasury told us that the post-2020 Multiannual Financial Framework is “not relevant to the UK” because “the UK is envisaged to play no part”.164 After setting out our concerns about the financial implications of extending all or part of the transition beyond December 2020 in writing in February,165 the Committee raised this matter with the Chancellor directly when he gave evidence to us in March. He told us:

“We are clear that if there were a question about extending the implementation period beyond the end of the MFF, that could not be by way of Britain’s participating in the next MFF. That would create all sorts of potential problems and, conceivably, long-tail liabilities, which we would not be prepared to take on. If we were to entertain that possibility (…) of an extension into the next MFF, that would be on the basis of a negotiated arrangement about any financial implications of that. It would not be by way of the UK’s adhering to and participating in the next MFF.”166

6.72If the Government was of the view that more time was needed to prepare the entirety of the UK’s new economic partnership with the EU as a ‘third country’, including the necessary regulatory and customs infrastructure, it could also theoretically seek an extension to the ‘full’ transition period on the terms already agreed. For example, the UK’s proposed legal text for the transitional period, published in March 2018, stated:

“The UK believes the Period’s duration should be determined simply by how long it will take to prepare and implement the new processes and new systems that will underpin the future partnership. The UK agrees this points to a period of around two years [from March 2019], but wishes to discuss with the EU the assessment that supports its proposed end date.”167

6.73The Prime Minister and the Secretary of State for Exiting the EU have also repeatedly referred to a transitional period lasting “around two years” from March 2019, i.e. until mid-2021. The Secretary of State for International Trade also recently said he could countenance a transition lasting longer than currently scheduled.168 However, in addition to facing substantial political and legal hurdles (not least by keeping the UK subject to an increasing volume of EU legislation over which it had no say), such an extension of the transition could also have a significant financial cost.

6.74Under the terms of the transitional arrangement and the accompanying financial settlement as set out in the March 2018 draft Withdrawal Agreement, the UK would pay into the EU budget until the end of 2020 as if it were still a Member State. Thereafter, it would remain liable for a share of outstanding expenditure commitments undertaken by the EU under the 2014–2020 MFF. In return, the UK would remain eligible for participation in almost all169 EU funding programmes on current terms (that is to say, as if it were still Member State). As part of the broader transitional arrangement, it would also remain part of the Customs Union and the Single Market to delay the imposition of the trade barriers that the UK becoming a ‘third country’ vis-à-vis the EU will impose by default while negotiations continue on a free trade agreement that, it is the Government’s ambition, will also have the effect of obviating the need for border controls. We reiterate that these financial commitments remain, at present, political only; they are not legally binding on the UK until the Withdrawal Agreement is ratified by both Parliament and the EU.

6.75If the Agreement is ratified and the transition were to be extended beyond December 2020 for any reason, the European Council’s April 2017 guidelines for the Brexit negotiations, which are binding on the European Commission in its negotiations with the Government, are unequivocal about the conditions:

“To the extent necessary and legally possible, the negotiations may also seek to determine transitional arrangements which are in the interest of the Union and, as appropriate, to provide for bridges towards the foreseeable framework for the future relationship in the light of the progress made. Any such transitional arrangements must be clearly defined, limited in time, and subject to effective enforcement mechanisms.

Should a time-limited prolongation of Union acquis be considered, this would require existing Union regulatory, budgetary, supervisory, judiciary and enforcement instruments and structures to apply.”

6.76As a result, the current proposal for a transitional arrangement (i.e. until end 2020) rests entirely on the “time-limited prolongation of the Union acquis”, which in turn relies—inter alia—on the application of the EU’s ‘budgetary instruments’. This includes the Multiannual Financial Framework, the mechanism for funding the EU budget (the Own Resources Decision) and the EU’s annual budgets. A straightforward reading of the EU’s position is therefore that for the duration of the transition, whatever its length, the UK would remain a contributor to the EU budget as if it were still a Member State. Any extension would therefore include additional contributions to the EU above and beyond the December 2017 financial settlement.

6.77We first raised concerns about the possible financial implications of Government’s continued ambiguity about the length of the transition in our Report on the 2018 annual EU budget.170 In the event of an extension, the UK would—from 1 January 2021 until the end of the transition—have to make payments towards the new Multiannual Financial Framework, potentially under the terms of a new Own Resources Decision171 (although the precise impact of the latter on any further UK contributions is unclear because of certain provisions of the Withdrawal Agreement which prevent retroactive changes that affect the UK’s overall financial contribution, see paragraphs 6.80 to 6.83 below). The Government will have lost its veto over both of those pieces of legislation before they are due to take effect.

6.78Therefore, an extension of the transition on current terms could have the following financial implications:

The UK rebate during an extended transition

6.79In addition to the general financial implications of an extended transition, there is some uncertainty about whether the terms of the Withdrawal Agreement as currently drafted would prevent the UK from facing any additional financial obligations, and stop the EU from abolishing the UK rebate on any of the Government’s contributions from 1 January 2021 onwards (i.e. on any UK contributions not covered by the financial settlement agreed late last year, which only runs until 31 December 2020).

6.80Article 128(2) of the Withdrawal Agreement states:

“By way of derogation from Part Four [on the transitional arrangement],173 amendments to Council Regulation 1311/2013 [the current MFF Regulation] or Council Decision 2014/335/EU [the current Own Resources Decision], adopted on or after the date of entry into force of this Agreement shall not apply to the United Kingdom in so far as those amendments have an impact on the United Kingdom’s financial obligations.”

6.81The clear purpose of this provision is to ensure that, from the start of the transitional period until the end of the current Multiannual Financial Framework in December 2020, the UK rebate cannot be abolished.174 The ‘correction’ would therefore be applied to the Government’s contributions in 2019 and 2020 as it did before the UK ceased being a Member State. More generally, any changes to the EU’s system of Own Resources that would alter the UK’s contributions after it formally exits the EU would not apply.

6.82However, whether those safeguards would continue to apply should the transition still be in effect from 1 January 2021 onwards is unclear. It should be borne in mind that Article 128 of the Withdrawal Agreement, and the legal text for the financial settlement as a whole, were drawn up based on the UK’s participation in the EU’s budget—as a contributor and a recipient—until the end of the current MFF on 31 December 2020. It seems unlikely that the EU-27 would agree to an extension to the transition on the currently-agreed terms, but allow Article 128 to effectively exempt the UK from having to contribute fully to the programmes and agencies of which it would still be a beneficiary. In particular, they would be likely to insist the UK also contribute under the terms of the new Own Resources Decision, which would after all also govern the EU-27’s contributions to the EU budget from January 2021.

6.83Therefore, any extension of the transition on its current terms could also lead the EU to require changes to the parameters of the financial settlement to make it reflect the extended length of the UK’s transitional participation within the EU’s structures. That could involve continued payments into the EU budget above and beyond the contributions agreed as part of the financial settlement, and potentially with no rebate on the contributions from 1 January 2021.

6.84The prospect of paying into the EU budget beyond 2020 for new expenditure commitments undertaken on the basis of a Multiannual Financial Framework over which the UK had no say would clearly be highly problematic, especially as the Council will be losing, in the UK Government, one of the EU’s main proponents of a restrictive budgetary approach.175 We therefore welcome the Chancellor’s comments that any extension would be conditional on the UK not being bound by the 2021–27 MFF Regulation.

The financial implications of the Government proposal for the Northern Ireland ‘backstop’

6.85One scenario that effectively involves an extension of certain elements of the transitional arrangement beyond 31 December 2020 is now official Government policy. It results from the Cabinet Office’s position on the ‘backstop’ to keep the border with Ireland free from any ‘hard’ infrastructure when Northern Ireland and Ireland cease to be jointly part of the shared European customs and regulatory territories.

6.86Back in December 2017, the Government and the European Commission agreed that the objective of avoiding regulatory and customs infrastructure on the Irish border would, “in the absence of agreed solutions”, be achieved through continued “full alignment” by the UK176 with EU rules that would make such controls unnecessary. The European Commission’s legal text for the ‘backstop’ was published in February 2018. It would require Northern Ireland to continue applying EU rules on goods, including product standards, VAT, customs and excise, with border checks by joint UK-EU teams taking place on goods entering Northern Ireland from the rest of the UK. This interpretation of the Joint Report was, rightly, immediately rejected by the Government.

6.87In June 2018, the Government proposed its own partial interpretation of this ‘backstop’ that would involve the entire UK effectively staying in most of the Customs Union (but with limited ability to negotiate free trade agreements separate from the Common Commercial Policy). The backstop would, if necessary, operate beyond 31 December 2020 for a “time-limited” period, which the Government “expects” would end by December 2021.177 Under its terms, the UK would continue to apply the Common External Tariff, and unspecified parts of the EU’s VAT and excise rules, in return for the “elimination of tariffs, quotas, rules of origin and customs processes including declarations on all UK-EU trade”. The Government also wants to keep the benefits of existing and future EU free trade agreements with ‘third countries’ which are in effect at the same time as the backstop, and a mechanism for the “UK national interest [to be] represented in future FTA negotiations affecting the UK” and an “ability to continue to help develop the rules that govern [EU] trade and customs policy”. The matter of continued regulatory alignment or cooperation affecting trade in goods is apparently to be covered by a separate Government proposal in the future.178

6.88Even as proposed, the ‘customs arrangement’ goes much further than the EU-Turkey Customs Union, the only precedent for such a close level of alignment with the EU on customs matters by a non-Member State of similar economic size.179 The EU-Turkey arrangement has not eliminated tariffs and quotas on all goods (as unprocessed agricultural goods are excepted); it does not remove the need for customs (or regulatory) controls at its border with Bulgaria and Greece; and nor does it obviate the need for VAT and excise controls on goods entering the EU from Turkey. Turkey also does not have any significant role in the EU’s trade negotiations with third countries, even though it must adjust its tariff barriers when the EU negotiates trade liberalisation with other countries.

6.89However, while such a partial extension of the transition by means of the backstop may be preferable from the Government’s perspective compared to the original Commission proposal, it is not currently provided for in the Withdrawal Agreement.180 This means there are only a few months left to negotiate such an arrangement in all its details, and the EU’s Chief Negotiator has already rejected the substance of the Government’s proposal.181 In any event, as the Chancellor recognised, this interpretation of the backstop (especially if it, ultimately, retained the free circulation of goods between the UK and the EU without any border controls) could still raise the question of a UK financial contribution.

6.90In particular, if a UK-wide backstop were acceptable to the EU, we consider it possible that the EU could request a financial mechanism to cover:

6.91With respect to the ‘temporary customs arrangements’ as part of the Irish backstop in particular, the fact that the UK would still effectively function as a point of entry into the EU for customs purposes, without any further customs controls when goods move from the UK to the EU, also implies HM Revenue & Customs could continue to transfer the lion’s share of customs duties collected (on imports destined for the EU) to the Union budget. If this was not the case, the EU would be deprived of a significant portion of its Traditional Own Resources (see paragraph 6.32 above), which would in turn require taxpayers in other Member States to compensate for this shortfall. We do not consider it likely that any customs duties passed to the EU by HM Revenue & Customs under this scheme would offset the costs charged to the Government for UK participation in EU agencies and programmes, because the EU would argue that it would receive those revenues even in the absence of the UK’s continued position within the Customs Union (in which case they would be collected by the Member State of import, rather than the UK).

6.92Clearly, a financial mechanism—even if it had to cover only a few of the elements described above—would not be straightforward to negotiate. With the time that is left before the Withdrawal Agreement must be finalised and submitted for ratification, it seems highly improbable that it could be accomplished as part of the Article 50 discussions. Therefore, the financial implications of the UK-wide ‘backstop’ which the Government appears to envisage would most likely have to be negotiated during the transitional period itself (and contained in a new UK-EU treaty, which could then face a veto either in the UK, the European Parliament and—possibly—in any of the EU’s 27 national parliaments). However, that in itself appears impossible because the EU has said the ratification of the Withdrawal Agreement is conditional on an agreement on the ‘backstop’.

6.93In light of unresolved questions we have raised in this Report, we have written to the Chief Secretary to the Treasury to request clarification of the Government’s intentions with respect to the potential financial implications of the Irish backstop and its proposals for a financial mechanism for participation in specific EU programmes.

Previous Committee Reports

None.


87 The main outstanding expenditure towards which the UK would contribute after 2020 is the reste à liquider (RAL), spending commitments which haven’t been paid yet, and liabilities such as staff pensions.

88 The MFF proposal contains payment appropriations totaling €1.104 trillion.

89 See for example our letter to the Chief Secretary to the Treasury of 22 February 2018.

90 In her Mansion House speech in March 2018, the Prime Minister said the UK wanted to obtain ‘associate membership’ of the European Chemicals Agency, the European Medicines Agency, and the European Aviation Safety Authority.

91 The Commission proposal for the European Defence Fund reserves participation to EU and EFTA-EEA states only.

92 The Prime Minister has said the UK wants to remain an ‘associate’ member of the European Chemicals Agency (ECHA), the European Medicines Agency (EMA) and the European Aviation Safety Authority (EASA).

93 See for example the Prime Minister’s speech of 21 May 2018: “In return [for a financial contribution] we would look to maintain a suitable level of influence in line with that contribution and the benefits we bring”; the Government’s May 2018 paper on the UK-EU Security Partnership: “For the UK to make a contribution to an EU programme or instrument, it would need to play an appropriate role in the relevant decision-making mechanisms”; or the letter by Universities Minister Sam Gyimah to Sir William Cash dated 23 April 2018: “The programme allows associated countries a suitable degree of influence, in recognition of the benefits they bring to the programme, and in line with their financial contributions”.

94 The EU-Turkey arrangement has not eliminated tariffs and quotas on all goods (as unprocessed agricultural goods are excepted); it does not remove the need for customs (or regulatory) controls at its border with Bulgaria and Greece; and nor does it obviate the need for VAT and excise controls on goods entering the EU from Turkey. Turkey also does not have any significant role in the EU’s trade negotiations with third countries, even though it must adjust its tariff barriers when the EU negotiates trade liberalisation with other countries.

95 For example, the EU has previously said the ‘full alignment’ backstop—effectively extending the Customs Union, single VAT area and Single Market for goods—is available only to Northern Ireland, not the UK as a whole. That raises the question that an extension of parts of the transition for the UK as a whole could not be negotiated in time for inclusion in the Withdrawal Agreement, necessitating further negotiations with the EU during the transitional period on a new treaty. This agreement would require fresh votes in the Council and the European Parliament, and possibly the EU’s national parliaments.

96 Other EU agencies which play a role in the Single Market for goods are the European Food Safety Authority and the Community Plant Variety Office.

97 The European Commission already indicated that as a possibility under its own ‘backstop’ proposal, where only Northern Ireland would stay in the Customs Union. The backstop as envisaged by the Government may also lead the EU to ask for an agreement on the level of subsidies for farmers. No developed country outside the Common Agricultural Policy has complete tariff-free access to the EU market for agricultural goods.

98 As noted, beyond 31 December 2020 the UK would still pay towards EU financial obligations that arose before that date but remained outstanding. Those contributions will decrease over time.

99 The Secretary of State (Liam Fox) told Sky News on 24 June 2018 that he “would be prepared to accept an extension to the Brexit transition period”. In late May 2018, the Times had already reported that “Britain will ask for a customs and regulatory alignment implementation period from 2021 to at least 2023 to avoid the need for infrastructure or checks on the border”.

100 Oral evidence by the Chancellor of the Exchequer, Q187 (5 March 2018).

101 Under the Treaties, the Own Resources Decision requires the unanimous approval of the Member States in the Council and “approved by the Member States in accordance with their respective constitutional requirements”. In the UK, under the European Union Act 2011, this requires an Act of Parliament.

102 Explanatory Memorandum submitted by the Department for Business, Energy & Industrial Strategy on the European Commission’s 2021–2027 Cohesion Fund proposals (13 June 2018).

103 The UK does not, in practice, have a veto anymore, as the MFF Regulation is likely to be adopted after the Government loses its seat on the Council on 29 March 2019.

105 The Commission removed the UK’s share of EU funding under the 2014–2020 EU budget to calculate the percentage increase compared to the proposed 2021–2027 MFF.

106 For comparison purposes this heading also includes the European Development Fund for development assistance to the ACP countries, even though the Fund is currently ‘off-budget’ and therefore not part of the 2014–2020 MFF.

107 Cohesion Policy is delivered through three main funds, the European Fund for Regional Development, the European Social Fund and the Cohesion Fund.

109 See article 311 TFEU.

110 Parliament granted its consent for the current Own Resources Decision by means of the European Union (Finance) Act 2015. The European Union Act 2011 also prevents the Government from abstaining on a vote, as that would effectively allow the legislation to be adopted by the other Member States and make it binding on the UK.

112 The Government noted that the 2014 Own Resources Decision “sees very little change to the system in place for the 2007 to 2013 MFF; there will be no new Own Resource, no EU-wide taxes, and no change to the UK abatement”. The Commission itself has stated that “the last substantial, qualitative change in the Own Resources system dates back to the 1980s” when GNI-based REVENUE SOURCE was introduced to underpin the increase of expenditure related to implementing the Single Market and the enlargement to new Member States.

113 The ‘other resources’ of the EU typically amount to less than 5 per cent of its annual revenue. These include for example the taxation of the salaries of EU civil servants, payments by ‘third countries’ for participation in EU programmes, and penalty payments imposed on Member States or businesses by the EU.

114 http://www.europarl.europa.eu/external/html/budgetataglance/default_en.html#united_kingdom.

115 Under the current system, the Value Added Tax bases of all Member States are harmonised in accordance with EU rules. This requires numerous corrections and compensations as well as the calculation of a weighted average rate. These bases are then capped at 50% of the Gross National Income base in order to address the regressive aspects of the VAT -based resource. Finally, a uniform rate of 0.3 per cent is levied on each Member State’s harmonised Value Added Tax base, with the exception of Germany, the Netherlands and Sweden which have a reduced call rate.

116 In practice, after the amount which remains to be covered after the TOR and VAT-based resources are accounted for is calculated, it is split into national contributions resulting from the application of a uniform call rate to the Member States’ Gross National Income. On average, the call rate has been at 0.6% over the past two decades, although it has risen to 0.7% over 2012–16.

117 Commission document SWD(2018) 172.

118 €1 = £0.88605 or £1 = €1.12860 as at 29 June 2018.

119 For example, the UK’s VAT receipts in 2017–18 amounted to £125.3 billion with a standard rate of 20%. Under the new calculation method, the UK’s standard-rated taxable base would have been £281.9 billion (£125.3 billion × 45% / 20%). With a call rate of 1 per cent, that would have required a contribution to the EU budget of £2.8 billion. The UK’s actual VAT-based contribution in 2017 was £3 billion.

120 Commission document COM(2018) 326.

121 These figures also include the European Development Fund, which is currently ‘off budget’ and therefore not included in the Own Resources ceiling of the MFF.

122 The CCCTB proposal consists of two separate Directives: one to legislate for the introduction of the ‘common’ tax base (i.e. the rules for calculating the corporate tax base), and a supplementary proposal for the ‘consolidation’ element (i.e. allowing for EU-wide profits to be filed as a single tax return, with taxation redistributed to the relevant Member States).

123 The Commission has propo sed that the use of the CCCTB would be compulsory for cross-border groups with revenues exceeding €750 million (£658 million) annually. Taxable profits of companies outside the mandatory scope of the CCCTB Directive (i.e. those of companies below the size threshold or outside the other criteria) would be excluded for the purposes of calculating the contribution to the EU budget.

124 According to the Commission, the total corporate tax base in the EU-27 (i.e. minus the UK) was estimated at nearly €380 billion in 2012.

125 The Franco-German ‘Meseberg Declaration’ of 19 June 2018 also contains a commitment to “put in place actual tax convergence between France and Germany regarding corporate tax”. Including a “common position on the Commission proposal for a directive establishing a Common Corporate Tax Base” which Paris and Berlin “will promote it jointly in order to support and accelerate the European project to harmonise the corporate tax base in Europe”.

126 Under the ETS Directive, the EU’s manufacturing industry receives a substantial share of its allowances for free, although the proportion will decrease from 80% in 2013 to 30% in 2020. The energy sector in some Member States also receives some of its emission allowances for free to modernise their infrastructure. Airlines continue to receive the large majority of their allowances for free in the period 2013–2020.

127 The Commission notes that the 10 per cent of allowances which are redistributed “for the purposes of solidarity, growth and interconnections” will be excluded from the calculations, as will the 2 per cent of allowances sold to finance the ETS Modernisation Fund (which will investment in modernising the power sector and wider energy systems and boosting energy efficiency in 10 poorer EU Member States).

128 Currently, 10 Member States have the possibility to allocate up to 40 per cent of their allowances for free. The UK is not covered by this optional scheme. For the purposes of the Own Resource, the hypothetical revenue arising from these allowances will be calculated using their market value.

129 See oral evidence by Energy Minister Claire Perry MP to the House of Lords EU Select Committee (21 March 2018). The Minister did not rule out the UK seeking to stay part of the EU ETS until the end of Phase 4 (which runs from 2021 to 2030).

130 The UK could also seek to establish its own ETS and ‘link’ it to the EU’s version. For example, under the terms of the EU-Switzerland Agreement, emission allowances that can be used for compliance under the EU ETS are recognised for compliance under the Swiss system and vice versa. See our Report of 21 February 2018 for more information on the Agreement, and the implications in the context of the UK’s exit from the EU.

131 See for more information on the EU Plastics Strategy our Report of [date].

132 See for more information on the amendment to Directive 94/62/EC on packaging and packaging waste our Report of 2 May 2018.

133 The recent amendment to the Packaging and Packaging Waste Directive will establish more precise “rules according to which Member States should report what is effectively recycled and prepared for re-use and can be counted towards the attainment of the targets”. The Commission notes, however, that “the data should be further improved, in particular for some Member States and as regards recycled plastics packaging”.

134 ICF Consulting Services Ltd (2018), Plastics: Reuse, Recycling and Marine Litter”, a study prepared for the European Commission (not yet published).

135 That year, the European Council at the Fontainebleau European Summit concluded that “any Member State sustaining a budgetary burden which is excessive in relation to its relative prosperity may benefit from a correction at the appropriate time”.

136 The European Commission notes: “Potential additional contributions by the United Kingdom honouring its obligations assumed as an EU Member State that have to be paid beyond 2020 could reduce the financing needs to be covered by Own Resources, particularly at the beginning of the next Multiannual Financial Framework. However, such contributions cannot be factored in with certainty as long as no withdrawal agreement has been signed with the United Kingdom.”

137 On 21 May 2018, the Prime Minister explicitly stated the Government was seeking formal association of the UK to the 2021–2027 Framework Programme for Research and the Euratom Research & Training Programme.

138 Speech by the Universities Minister (Sam Gyimah) on 28 May 2018.

140 HM Government, “Technical note on UK participation in Galileo“ (May 2018).

142 The Government’s May 2018 policy paper on the ‘Framework for the UK-EU Security Partnership’ said it wants to “explore a mechanism that allows for future UK-EU cooperation in specific geographic and thematic areas, where it is in our mutual interests. For the UK to make a contribution to an EU programme or instrument, it would need to play an appropriate role in the relevant decision-making mechanisms. UK entities would be eligible to deliver EU programmes and receive funding”.

143 Commission document SWD(2018) 172.

144 This exclusion of the UK from ‘sensitive’ EU programmes can be triggered at the EU’s discretion under Article 122(7) of the draft Withdrawal Agreement, to which the Government has already agreed. That effectively implies the Government would be making financial contributions towards EU programmes where UK entities would not be eligible to receive any funding back.

145 European Council Guidelines on Article 50 (23 March 2018).

146 The European Commission’s ambition is for the MFF Regulation to be adopted prior to the European elections in May 2019.

147 In a pure ‘third country’ scenario, where the UK voluntarily seeks case-by-case participation in EU programmes, the Own Resources Decision would not be relevant as the UK would not pay into the EU budget as a Member State or be bound by EU budgetary legislation.

148 By way of example, under the financial mechanism as it applies to (for example) Norway, where the UK’s share of the GDP of the EU-27 and the UK combined is 16 per cent and the EU’s budget for programme Y in year X is €100 million, the UK’s contribution would be €16 million (taking the total budget for programme Y to €116 million that year). The exact calculation can vary: for example [Switzerland and ITER?].

149 This EU-third country financial mechanism in advance as part of a wider agreement: it does not allow for the associated countries to negotiate their contribution year-by-year, based for example on the amount of funding they received back from a specific EU programme to which they contributed. There is no rebate, as the UK enjoys at present as a Member State.

150 See for example the Prime Minister’s speech of 21 May 2018: “In return [for a financial contribution] we would look to maintain a suitable level of influence in line with that contribution and the benefits we bring”; the Government’s May 2018 paper on the UK-EU Security Partnership: “For the UK to make a contribution to an EU programme or instrument, it would need to play an appropriate role in the relevant decision-making mechanisms”; or the letter by Universities Minister Sam Gyimah to Sir William Cash dated 23 April 2018: “The programme allows associated countries a suitable degree of influence, in recognition of the benefits they bring to the programme, and in line with their financial contributions”.

151 The Horizon.

152 The Commission has proposed a total budget for Horizon Europe over the 2021–2027 period of €100 billion. As the UK’s share of the cumulative GDP of the EU-27 and the UK is 16 per cent, that would amount to a total contribution over that period of €16 billion or €2.3 billion per annum, taking the total budget for the Programme to €116 billion (notwithstanding similar contributions from other ‘third countries’). The UK’s contributions for participation in specific EU programmes as a ‘third country’ will not benefit from its current rebate.

153 For example, a different financial mechanism could be in place under the Framework Programme for Research (where the Commission has proposed linking the UK contribution to its status as a net beneficiary while it was a Member State), or if the Member States do not accept the Commission proposal to merge the off-budget European Development Fund with the Neighbourhood & Development Cooperation Instruments, which would potentially allow the UK to contribute only to a sub-set of the EU’s development instruments and therefore lower its contributions.

154 Calculated using a 16 per cent proportionality factor combined with the provisional average EU budget for each programme in the 2021–2027 period.

155 For FP9, the European Commission has proposed an ad hoc financial mechanism for the UK that relies on the UK’s receipts from the current Framework Programme for Research as it is currently net beneficiary from the Programme. If that proposal is accepted by the European Parliament and the Member States, and the UK still wants to associate, its contribution may therefore be higher.

156 Switzerland has an ‘association’ agreement for the EU’s satellite navigation programme (i.e. Galileo), which nevertheless does not provide the same access to the Programme as an EU Member State. However, there is no precedent for something similar for the Copernicus earth observation programme.

157 The European Commission proposal for the European Defence Fund 2021–2027 is open to EU Member States and the EFTA-EEA countries Iceland, Liechtenstein and Norway only (though this can be changed by the European Parliament and the Council over the course of the legislative procedure). The pilot project for part of the European Defence Fund, the Preparatory Action for Defence Research (PARD) is open to Norway via the EEA Agreement. However, it has reportedly not received any funding from it despite making a contribution. The other element of the Fund for the 2018–2020 period, the Defence Industrial Development Programme, does not currently contain any formal mechanism for full ‘third country’ participation.

158 The NDIC Instrument is the first time the EU’s various development assistance instruments would be merged into a single funding programme. It would also mark the first time the European Development Fund, which finances assistance to the ACP countries and Member States’ overseas territories, would be fully ‘budgetised’. If the EDF remained ‘off-budget’ as it is at present, UK participation in that particular programme might be easier as it is constituted by separate treaty, meaning there are fewer limits to participation by a non-EU country (especially in terms of participation in decision-making and governance structures). See for more information our Report of 16 May 2018, in particular paras. 4.16 to 4.20.

159 Speech by Prime Minister Theresa May (2 March 2018): “We will also want to explore with the EU, the terms on which the UK could remain part of EU agencies such as those that are critical for the chemicals, medicines and aerospace industries: the European Medicines Agency, the European Chemicals Agency, and the European Aviation Safety Agency.”

160 These regulatory agencies are part of the core institutional framework for the Single Market, which the Government has committed to leaving. While EASA offers the opportunity for non-EU countries to remain covered by its functions (in return for continued UK application of EU aviation legislation), ECHA and EMA do not foresee this possibility for countries outside of the Single Market. Continued use of their regulatory roles would also necessitate the UK remain bound by the EU’s legislation on chemicals and pharmaceuticals.

161 In 2018, ECHA, EMA and EASA will receive funding from the EU budget totalling €84.4 million (£74 million). While the UK’s payments would therefore be fairly limited, it would still need to be negotiated with the EU before these new arrangements could take effect.

162 Switzerland and the EU are currently in discussions about the future of the former’s Enlargement Contribution, which Switzerland proposes should amount to approximately £1 billion over a ten-year period.

163 For the purposes of this Report, we have presumed that the Withdrawal Agreement, including the transitional arrangement, takes effect on 29 March 2019 as planned. The European Commission has published a series of ‘Brexit preparedness notices‘ with sectoral information on the implications for both UK and EU businesses of the UK becoming a ‘third country’.

164 Explanatory Memorandum submitted by HM Treasury (29 January 2018).

165 Letter from Sir William Cash to Elizabeth Truss (21 February 2018).

166 Oral evidence by the Chancellor of the Exchequer, Q187 (5 March 2018).

168 The Secretary of State (Liam Fox) told Sky News on 24 June 2018 that he “would be prepared to accept an extension to the Brexit transition period”. In late May 2018, the Times had already reported that “Britain will ask for a customs and regulatory alignment implementation period from 2021 to at least 2023 to avoid the need for infrastructure or checks on the border”.

169 Controversially, UK companies were not allowed to bid for new contracts for the EU’s Galileo satellite programme even if the transition takes effect in March 2019. It is unclear whether a similar exception will apply to the European Defence Industrial Development Programme.

170 See the Committee’s Report of 19 December 2017.

171 Article 122 of the draft Withdrawal Agreement stipulates that “Union law shall be applicable to and in the United Kingdom during the transition period”, and that “during the transition period, any reference to Member States in the Union law (…) shall be understood as including the United Kingdom”. Article 2 defines “Union law” as including “the acts adopted by the institutions (…) of the Union”, therefore including the Own Resources Decision and the MFF Regulation.

172 The European Commission tabled its proposals for reform of the Common Agricultural Policy in June 2018. If agreed by the European Parliament and the EU-27, they would take affect at the same time as the new MFF, i.e. on 1 January 2021.

173 Part Four of the Withdrawal Agreement contains the transitional arrangement, i.e. the continued applicability of all EU law to the UK as it did while it was a Member State.

174 At present, the UK has an effective veto over the abolition of the rebate. From the start of the transition, it will lose that veto, hence the need for the rebate to protected in the Withdrawal Agreement.

175 In 2013, the UK Government secured the [first] real-terms reduction in the MFF compared to the previous budgetary period.

176 The EU interpretation of this was that such alignment would apply to Northern Ireland only.

177 The Government’s technical note of 7 June 2018 does not refer to the need for regulatory alignment in areas such as sanitary and phytosanitary controls or other product standard-related regulations.

178 If the UK were to leave the Common Agricultural Policy on 1 January 2021 it is unclear how it could remain in the Single Market for agricultural goods without facing tariff barriers.

179 Monaco and San Marino, which are sovereign, are also part of the EU’s customs territory, but by virtue of their small size and economic dependence on France and Italy respectively.

180 The latest public version of the Withdrawal Agreement was published by the Government and the European Commission on 19 March 2018.

181 If the Government considered (the possibility of) an extension necessary, but was unwilling to agree to a prolongation on the same terms that are to apply until the end of 2020 (i.e. full application of EU law and contributions into the EU budget), we do not see how the mechanism could be included in the Withdrawal Agreement. Consequently, the UK would have to negotiate a new treaty with the EU at some point between March 2019 and December 2020, with the EU needing to act on a different legal basis and the possibility that any ‘partial’ extension could ultimately be blocked by the remaining Member States (or their national parliaments), or the European Parliament.

182 We do not consider it likely that any customs duties passed to the EU by HM Revenue & Customs under this scheme would offset the costs charged to the Government for UK participation in EU agencies and programmes, because the EU would argue that it would receive those revenues even in the absence of the UK’s continued position within the Customs Union (in which case they would be collected by the Member State of import, rather than the UK).

183 The same would apply in the case of the Government’s ‘Customs Partnership’, where the UK would apply EU customs rules and tariffs on goods entering the UK but destined for the EU. However, under this system there would be additional complications as the Own Resources would need to be calculated based on the proportion of goods destined for the EU only, and not all goods entering the UK as is the case while it is in the Customs Union. Moreover, it is unclear if the TOR contribution would be calculated based on the EU’s tariff as it applies to the third country from which the goods are imported, or the tariff that applies to goods imported from the UK.

184 The negotiations would also have to touch on the implications of the UK’s exit from the Common Agricultural Policy for the access of UK agricultural goods to the EU market.

185 Developing countries have full or partial tariff- and quota-free access to the EU market for agricultural goods under the Generalised System of Preferences and the ‘Everything But Arms’ programme.

187 For the 2014–2020 period, the EEA and Norway Grants combined amount to €2.8 billion (£2.5 billion). However, the UK scheme would have to reflect the extent to which it remained part of the Single Market and its larger economic size.




Published: 10 July 2018