The Internal Market Bill and what it could mean for subsidy controls post-Brexit transition period

Last month, the UK Internal Market Bill (“Bill”) passed its first hurdle in the House of Commons. The aim of the Bill is to ensure there is no regulatory divergence resulting in barriers to trade within the UK following the end of the Brexit transition period (“Transition Period”). This would allow the frictionless trade of goods and services to continue across England, Scotland, Wales and Northern Ireland through a system of mutual recognition and non-discrimination.

The Bill has proved controversial, however, given that, as currently drafted, it would enable the UK Government (“Government”) to override parts of the Withdrawal Agreement, in particular the Northern Ireland Protocol (“Protocol”). The Protocol was designed to ensure frictionless trade between the EU and Northern Ireland (thereby avoiding a hard border between Ireland and Northern Ireland). It aimed to achieve this by ensuring that Northern Ireland remained subject to certain EU laws following the end of the Transition Period (notably certain EU single market rules and State aid rules).

Should it be passed into law, the Bill could have far-reaching consequences – not least in the area of foreign subsidy controls, by giving ministers the ability to enact regulations which could disapply State aid rules in relation to Northern Ireland. The Bill also grants the Government (and not devolved powers) the exclusive power to decide which aid related to Northern Ireland needs to be notified to the EC under the State aid regime. In addition, the Government has published further details of its plans for a post-Brexit subsidies regime; confirming that it would follow WTO subsidy rules until the appropriateness of a UK-specific foreign subsidies regime has been considered. This article focuses on how the Bill would affect the application of EU State aid rules post-Transition Period, and the UK’s future domestic subsidies regime.

What does the Bill aim to do?

Following the end of the Transition Period, the UK will have new powers to regulate areas that were previously under the exclusive purview of the EU, including agri-food chemicals, waste and fisheries. These powers extend to devolved administrations as well as central Government. As a result, the Government has been engaging with the administrations of Scotland, Wales and Northern Ireland to establish common frameworks for specific sectors. The Bill is the first step the Government has taken to ensure there will be no regulatory divergence or barriers to trade within the UK as a whole from 1 January 2021.

What is the Protocol?

As part of the Withdrawal Agreement, the UK and the EU agreed the Protocol to avoid a hard border between the countries in the event of no-deal. Under the Protocol, Northern Ireland will continue to align with certain EU single market rules for goods and the wholesale electricity market, including State aid and customs laws. In particular, Article 10 of the Protocol stipulates that the EU State aid regime will continue to apply in respect of measures affecting trade in goods between Northern Ireland and the EU (including Ireland). This effectively preserves the State aid rules, and the exclusive jurisdiction of the European Commission (“Commission”), in respect of such measures.

How could the Bill change the Protocol?

The Bill proposes the following measures regarding the application of the Protocol. In particular, the Bill would:

  • grant the Secretary of State the power to make regulations in connection with Article 10 of the Protocol. The Bill does not stipulate what such regulations must do, but does provide suggestions as to what they may cover, such as to stipulate that the Article is not to be interpreted in accordance with EU case law;
  • give the Secretary of State power to disapply or modify the effect of Article 10, “notwithstanding any relevant international or domestic law with which they may be incompatible or inconsistent”. This could result in ministers unilaterally changing the application of the Protocol in the UK;
  • disapply the direct effect of the Withdrawal Agreement in UK law, in relation to any other provisions of the Bill, or regulations made under it, which would be incompatible with the Withdrawal Agreement; and
  • give UK ministers the power to provide financial assistance for (among others) promoting economic development in any area of the UK, providing infrastructure (including utilities, railway facilities etc.) and supporting cultural, sporting and educational activities etc. This subsidy-giving power would represent an extension of Westminster’s powers in the devolved jurisdictions.
  • provide that no public authority apart from the Secretary of State may comply with the requirement to notify aid to the Commission under Article 10.

If the Bill is passed as proposed, the Government would be able to issue regulations to disapply the EU State aid rules that would otherwise apply to measures potentially affecting the trade in goods between Northern Ireland and the EU.

What does this mean for future subsidy controls?

State aid rules have been one of the more contentious elements of the negotiations between the UK and EU on the future economic relationship. Boris Johnson has signalled that he sees the freedom to diverge from the EU’s State aid rules as one of the “benefits which will directly result from leaving the EU.”

On the same day that the Bill was introduced to Parliament, the Department for Business, Energy and Industry (“BEIS”) announced that, from 1 January 2021, the UK will no longer follow EU State aid rules and will instead follow WTO foreign subsidy rules. The Government will also consult on whether the UK domestic regime on foreign subsidy control needs to go any further than the WTO rules. In the event that the EU and UK do not reach an agreement on State aid as part of a free trade agreement, it is possible that the WTO rules could apply to the UK on a permanent basis. The Government also announced that it would observe its obligations under any future trade agreements.

Although the concept of a ‘subsidy’ under the WTO rules is broadly similar to ‘State aid’ in EU law, the State aid rules are far more comprehensive, as set out below:

  • Scope of the rules: The WTO rules apply only to goods, whereas State aid rules apply to goods and services.
  • Prospective versus reactive regulation: State aid rules apply prospectively – i.e. aid must be approved by the Commission before it is granted, and the starting point is that state subsidies are generally illegal unless they can be justified. Under the WTO rules, there is a presumption that any foreign subsidies are permissible unless another member country makes a complaint (i.e. the rules are reactive).
  • Enforcement mechanism: Under State aid rules there are remedies available to companies and individuals. Conversely, WTO rules are reliant on state-to-state enforcement.
  • Remedies: State aid rules provide for recovery of unlawful State aid from the recipient company. Conversely, there is no power for the WTO panel to order unlawful subsidies are returned to the relevant member state. States are only required to end the subsidies where they require recipients to meet export targets or to use domestic or imported goods. For all other types of subsidies, the only remedy available is applying a countervailing duty, constituting a tax on the imports of a specific category of goods. This would be applied to all goods within a specific category, rather than being targeted at a particular company (and therefore does not remedy the distortion brought about by the subsidy).
  • Uncertainty: Finally, the lack of previous decisions means that there is little case law on WTO rules, which will increase legal uncertainty about the legality of UK state support post-Brexit.

BEIS has further announced that it will consult on the design of the future UK subsidy regime. It is likely that a key focus of this regime will be to address the possibility of subsidy races between the different parts of the UK. However, it is not yet clear how the Government proposes that will work in practice and whether the UK will seek to go further than the WTO rules with respect to foreign subsidies.

Finally, the Bill reserves to the UK Parliament the ability to legislate for a new foreign subsidies regime, to the exclusion of devolved legislative assemblies of the UK nations. The UK Parliament is given exclusive power to set the “[r]egulation of the provision of subsidies which are or may be distortive or harmful by a publish authority to persons supplying goods or services in the course of a business”. State aid is currently not a matter specifically provided for in the existing devolution settlements with Scotland and Wales.

Conclusion

The Bill has not yet been passed into law and may be amended on its passage through Parliament. Indeed, some amendments have already been made at committee stage, in particular requiring the Government to obtain Parliamentary approval before bringing into force the provisions that would conflict with the Withdrawal Agreement. The Bill completed all its stages in the House of Common on 29 September 2020 and is currently in the House of Lords for consideration. The Commission has also commenced legal action with respect to the UK’s plans.

The decision that the UK will follow WTO subsidy rules raises several interesting issues. Given the close integration between the economies of the EU and UK (and between Northern Ireland and Ireland in particular), and the potential for governmental subsidies to have distortive effects, clear guidance from the Government on the application of WTO subsidy rules will be needed. In addition, it’s notable that the effectiveness of WTO subsidy rules has recently been called into question, with countries such as Japan and the United States publishing new initiatives for enhanced rules on industrial subsidies. Most recently, the Commission published a proposal for new powers to address distortions to the internal market caused by non-EU governmental subsidies - in particular those from China) (see our June client alert here). This general trend towards increased foreign subsidies regulation was also shared by the UK as recently as March, when the Minister for International Trade Liz Truss stated that the Government would “make the case to update the WTO rulebook to tackle underlying trade tensions such as industrial subsidies”.

Although the Government has asserted that it does “not want a return to the 1970s approach of picking winners and bailing out unsustainable companies with taxpayers’ money”, it is clear that it is seeking greater flexibility to support new and emerging industries. The Bill evidences that the UK favours a looser subsidy control framework than that within the EU (based, for instance, on the free trade agreement between the EU and Canada). Given the importance to the EU of strong "level playing field" provisions on State aid, however, the scope of any future domestic subsidies regime is likely to be impacted by ongoing negotiations with the EU.