How Free Trade Zones could be the answer to cross-border trade post-Brexit

14 Nov, 2017

Brexit enables change

Brexit is a once in a generation change and gives the government a sheet of blank paper in structuring the UK’s future international trade arrangements. The government is committed to making the UK “more open and outward looking than ever before”. One area of potential opportunity which would be possible if the UK left the Single Market and Customs Union would be to reinstate Free Trade Zones (FTZs) in the UK. FTZs already exist in a limited fashion in the EU despite EU State Aid controls creating a barrier to implementation and are commonly used throughout the world.

It is interesting to note that FTZs are not mentioned in the government’s latest whitepaper on the UK’s future trade policy published on 9 October 2017 [pdf]. However, they do appear to be under consideration, given that there have been questions asked of politicians on recent editions of the Newsnight TV programme [a weekday current affairs programme specialising in political analysis] and discussion had with government officials by trade bodies.

As a member of the EU, the UK has been unable to negotiate its own individual trade agreements with other countries and many Brexit campaigners consider that third countries such as the US, Canada, Australia and India and emerging markets in Africa and South America present significant trading opportunities that can be better developed when the UK is able to negotiate its own, bespoke trade terms, unrestricted by EU frameworks.

At the same time, the UK has a significant amount of trade with the EU which UK businesses will want to maintain once it has left the EU. Given the UK’s close physical proximity to the EU, it is well placed to continue to sell into those markets and the use of FTZs could help to incentivise businesses to remain in the UK (rather than re-locate to the EU) or even attract new investment from foreign companies that could expand by using the UK as a base for selling into the EU, as well as the home UK market.

What is a Free Trade Zone?

FTZs are designed to both facilitate international trade and to promote economic development of the region in which they are located. There are currently no operational FTZs in the UK; while there are a number of ports which have been authorised in the past, none have active authorisations. Post-Brexit, the UK could have the freedom to set its own trade policy and to re-introduce FTZs.

An FTZ is an area that is physically within a country but legally outside of it for tax purposes. An FTZ would need to be a designated physical area. It would not be a single building, but a geographical location. It would most likely entail an enclosed area where the flow of goods and people entering and exiting could be controlled. This is important as there would be a need to prevent criminal behaviour relating to the illegal entry of people or to the unpaid import taxes for goods.

Put simply, an FTZ allows goods to be imported, manufactured, processed and re-exported without the payment of import taxes, which only fall due when the goods are removed from the zone and entered into the domestic economy. The FTZ may also offer tax incentives such as lower corporation or payroll taxes. It may also include non tax-incentives such as grants for research and development activities.

Removal of technical barriers

Whilst the EU has permitted several FTZs to be established in the EU, for example at Shannon Airport and in Katowice, it has been very difficult for governments to do so because of EU State Aid rules. Under these rules a measure constitutes (illegal) state aid if it:

  • involves the transfer of state resources
  • has potential distortive effects on competition and trade in the EU market, and
  • confers a selective advantage to the recipients.

Once outside of the EU, the UK should not be subject to the EU State Aid restrictions which would allow the government the freedom to introduce one or more FTZs in the UK as part of its international trade strategy.

FTZs used widely elsewhere in the world

Worldwide FTZs are a ‘well trodden path’, so there is plenty of practical experience on which the UK could draw. They are used widely across the world, particularly in the US, South America, Canada and Asia. Official figures are hard to come by but it is thought that several thousand FTZs exist globally. The precise format varies, but it is very common for governments to use FTZs to encourage local business and economic investment.

The level of tax support and other incentives would need careful consideration. The payment of import duty is a cost that can not be reclaimed by businesses, so a likely approach would be to reduce the level of UK corporate income tax within the FTZ to an amount that counters the financial burdens of increased duty tariffs given that all trade between the UK and other countries would lead to imports into those markets and be potentially subject to duty, unless free trade agreements are reached. Other incentives of FTZs could take the form of:

  • reduced payroll taxes
  • grants for research and development spend, and/or
  • reduced regulatory compliance requirements.

There continues to be much debate about the amount of taxes paid by multinational companies around the world and the UK government would most likely want to avoid setting itself up as an offshore tax haven. Such a move would run counter to its stated aims of “…seeking a new, deep, and special partnership with the European Union” and risk inflaming relationships with the EU and probably provoke higher import tariffs on goods shipped from the UK into the EU.

Ultimately, the UK would have freedom to shape a FTZ and the tax and other incentives that are offered. Indeed, if there were multiple FTZs within the UK, each could have a slightly different set of incentives if that were thought to be appropriate.

Summary

FTZs are commonly used throughout the world and, post-Brexit, the UK government would no longer be subject to the same EU law restrictions that effectively prevent their creation in the UK at the moment. FTZs are generally regarded as supporting the export market. This is an area that the UK aims to grow both in volume and value by being outside of the EU and therefore able to negotiate its own trade deals. As well as being a designated area that is free of import duties, additional benefits, such as tax and regulatory incentives could be offered in order to retain businesses in the UK or, more optimistically, encourage additional investment in the UK. FTZs could have a significant role to play as part of the government’s post-Brexit international trade strategy.

This article first appeared in Bloomberg BNA.

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