Taxation of asset holding companies in alternative fund structures - draft legislation published
Draft legislation as part of Finance Bill 2021-22 has been published in respect of the much anticipated new regime for asset holding companies (the qualifying asset holding company (QAHC) regime).
The new regime forms part of the government’s wider review of the UK’s funds regime and seeks to enhance the UK’s competitiveness as a location for asset management and for investment funds. The stated aims are twofold: first, to tax investors directly where QAHCs are used to facilitate the flow of capital, income and gains between investors and underlying investments; and second, to tax QAHCs in proportion to the activities they perform.
The regime is only intended to be available to certain types of investment arrangements and it will not have any impact in respect of the taxation of profits from trading activities, UK real estate or intangibles.
Tax benefits for QAHCs and investors
The tax benefits proposed to be afforded to QAHCs and their investors are generous and address longstanding issues that have historically prevented the use of UK companies as holding companies for investment funds. The aim is to bring the tax treatment of QAHCs more into line with the tax benefits that are already available through the use of non-UK companies, to maintain the UK’s attractiveness as a fund jurisdiction. The qualifying part of the QAHC’s business will be ring fenced from its other activities for this purpose.
The proposals offer the following key benefits:
- a broader exemption from corporation tax on gains than is currently afforded by the substantial shareholding exemption;
- exemption from corporation tax on profits from overseas property businesses that suffer non-UK tax;
- greater ability to deduct interest payments for corporation tax purposes (and on an accruals basis) and removal of the requirement to withhold income tax from interest payments to QAHC investors; and
- capital treatment on repurchases of share capital by the QAHC from individual investors, with a stamp taxes exemption for the QAHC.
As expected, the generosity of the tax changes is matched by the stringency of the tests limiting the availability of the new reliefs. We have set out some of the most important points below.
QAHC qualifying conditions
It is proposed that a company (other than a UK REIT) will constitute a QAHC if it:
- is resident in the UK;
- meets both the “ownership” and “activity” conditions (described below);
- is not listed or traded on recognised stock exchange or any other public market or exchange; and
- has elected to be a QAHC. That election will be revocable.
The ownership condition is directed at ensuring that no more than 30% of the “relevant interests” in the company are owned by investors other than diversely owned funds managed by regulated managers, or certain institutional investors – so called “category A investors”. Category A investors include QAHCs, qualifying funds (broadly meaning diversely held collective investment schemes or alternative investment funds) and certain other institutional investors such as REITs and charities.
For this purpose, the definition of “relevant interests” draws on the rules for group and consortium relief: is broadly concerned with voting power and beneficial entitlement to distributions of profit and assets on a winding up, and takes the highest of any of those proportions. A notable difference from the group/consortium relief rules is that the proposed test also has reference to sub-categories of profits or assets where securities are in issue which have different entitlements by reference to the performance of those sub-categories. This is intended to address ‘side pocket’ arrangements, i.e. where a QAHC permits a non-category A investor to take equity in return for a contribution of assets where the equity tracks the contributed assets to the exclusion of other shareholders in the potential QAHC.
The legislation contains detailed provisions to identify (among other things): (i) the profits or assets available for distribution by a potential QAHC to which each person with a relevant interest is treated as beneficially entitled; and (ii) the circumstances in which a relevant person will be treated as being beneficially entitled to those profits or assets (e.g. in respect of carried interest arrangements and tax transparent qualifying funds).
The Explanatory Note to the Finance Bill 2021-22 (the Explanatory Note) indicates that where funds are required to have a regulated fund manager, it will need to be independent in order for companies owned by the fund to qualify as QAHCS. Draft provisions that will give effect to this requirement are yet to be published.
The activity condition will be met when:
- the main activity of the potential QAHC is investing its funds with the aim of spreading investment risk and giving investors in the company the benefit of the results of the management of its funds; and
- any other activities of the company are not carried on to any substantial extent.
‘Substantial extent’ is not defined for these purposes. HMRC take the view that substantial extent equates to 20% or more of a company’s activities in other contexts, notably the test for determining whether a company is trading for certain purposes, but this is certainly not universal across the tax code. The Explanatory Note suggests that this is intended to ensure that trading activity is at a “minimal level”, for example to permit the provision of intra-group management services to related companies for modest fees, which may suggest a lower threshold. Clarity on this point is needed either through specific provisions or guidance from HMRC.
Call for comment
The draft legislation and further detail (including the Explanatory Note) is available here.
Interested parties are invited to raise questions or give comments (email@example.com) by 14 September 2021.