UK Asset Holding Companies: Consultation response and draft legislation
HMT publish draft legislation and second consultation response in respect of the core aspects of the proposed Asset Holding Company regime.
HMT publish draft legislation and second consultation response in respect of the core.....
On 20 July 2021, HM Treasury (HMT) published draft legislation in respect of the core aspects of the proposed Asset Holding Company (AHC) regime alongside HMT’s response to the second consultation document. The proposals reflect many of the suggestions put forward by the industry as part of the working group discussions with HMT. The AHC proposals are intended to address barriers relating to the use of UK companies within fund and investment structures. As expected, HMT plans to implement a new regime for AHCs which works in conjunction with the existing corporation tax framework. The AHC regime is part of the planned wider reform to the UK regime for investment funds with the intention of increasing the competitiveness and take-up of UK structures. We comment on the key developments and our initial thoughts in this article.
The AHC regime
Entry to the regime
The regime will be elective and UK resident companies, where they meet certain conditions, will be able to elect to become a Qualifying Asset Holding Company (QAHC). As expected, the eligibility requirements to become a QAHC will include an ownership and activities condition.
In relation to the ownership condition, the draft legislation proposes a minimum ownership threshold of 70 percent by certain types of investor, referred to as ‘Category A’ investors. The condition must be met on an ongoing basis, but there are special provisions relating to how carried interest should be treated. The definition of Category A investors includes certain qualifying funds, qualifying institutional investors, QAHCs and a Minister of the Crown. In order for a corporate fund to be qualifying it must meet a ‘non-close’ condition and, in the case of other funds, the genuine diversity of ownership condition. HMT also notes in its response to the consultation that it is still assessing how to incorporate an independence requirement for qualifying funds. Qualifying institutional investors includes certain life insurance, sovereign, pension, and charitable investors.
The activity condition will require investment with the aim of spreading investment risk and for other activities to not be carried on to any significant extent.
HMT also note in their response to the consultation that it is still being considered whether a minimum capital investment is appropriate. It is suggested that this could be in the region of £50 - £100 million, including debt finance.
Taxation of QAHCs
The QAHC regime will broadly operate with a special regime and ringfence for the qualifying activity of the QAHC. The qualifying activity will relate to certain activities including investment in shares, overseas real estate, and creditor relationships. Activity outside of the ringfence will be subject to the normal corporation tax rules.
Within the qualifying activity ringfence the corporation tax rules will apply with a number of amendments such that a QAHC should generally have little to no tax liability in respect of its qualifying activity. The more significant amendments / tax rules within a QAHC are described below:
- Chargeable gains on shares and overseas property will be exempt from corporation tax on chargeable gains. There will not be a need to consider the conditions of the substantial shareholding exemption (SSE). However, the Government is considering introducing targeted rules to prevent the enveloping of certain non-qualifying assets;
- Loan relationships will continue to be subject to corporation tax. However, the late paid interest rules and distribution rules will be adjusted such that a QAHC should expect to be able to receive deductions for profit participating debt instruments such that corporation tax should only apply to a financing margin;
- Overseas real estate income and gains will be exempt so long as there is taxation in the source country;
- QAHCs will broadly be exempt from the duty to withhold UK income tax from UK source interest payments made to investors to the extent that payments are made in respect of the qualifying activity of a QAHC;
- Group relief and the tax neutral transfer of assets will not be available between QAHCs and other UK companies. However, multiple QAHCs may form a group, with two notional groups being created for qualifying and non-qualifying activity;
- The Government is proposing an exemption from Stamp Duty / Stamp Duty Reserve Tax (SDRT) for the repurchase of shares and loan capital by a QAHC, subject to an anti-avoidance provision. A broader exemption for the transfer of QAHC shares or loan capital is not proposed; and
- UK property business and gains (including UK property rich entities) will be excluded from qualifying activities.
There are a number of areas where HMT has reported that the position is still undergoing consideration. This includes in relation to hybrid mismatches and the corporate interest restriction. The HMT consultation response notes that the Government does not consider that there is a case for making changes to the Controlled Foreign Company (CFC) rules. Specific transfer pricing rules are not necessarily anticipated, however specific guidance may be provided.
Existing companies will be eligible to join the regime. The ring-fenced assets of the company will be treated as disposed of and repurchased at market value on entry into the regime – and it may be possible to rely on exemptions such as the SSE. There will also be a deemed disposal when a company leaves the regime.
Rules for companies which expect to subsequently qualify are being considered (e.g. for warehouse type investments). It is also proposed that there may be a breach regime, such that QAHCs may not immediately fall out of the regime for a minor breach of a condition.
Treatment of UK investors in QAHCs
- The Government plans to turn off certain rules which have the effect of treating the premium on a share buy-back as a distribution. This should facilitate the ability for profits to be repatriated from a QAHC in the form of capital. However, the consultation response notes that suitable safeguards are still being considered in order to prevent the deferral of tax or conversion of income into capital;
- The existing framework will continue to apply to debt instruments, including the deeply discounted security and excluded index securities rules;
- The position in relation to the possible consequences of the employment related securities rules applying to carried interest received by fund professionals serving on the board of QAHCs is still being assessed; and
- The HMT consultation response notes that the Government is still considering the position in respect of the situs of QAHCs, and whether special treatment for the remittance basis of tax and inheritance tax may be appropriate.
Further matters and timing
QAHCs are expected to have certain information reporting requirements as part of their tax compliance. It is noted that HMRC may require information in order to monitor the profile of QAHC returns in order assess the suitability of the tax treatment by UK investors. The rules also may incorporate further protections in the form of targeted anti-avoidance rules.
Alongside the main proposals relating to QAHCs, the response to the consultation confirms that there will be reforms to the Real Estate Investment Trust (REIT) regime.
It is anticipated that the rules will be subject to further consultation, with a view to the QAHC regime being available from 2022/2023.
The release of the draft AHC legislation and summary of responses to the second AHC consultation is a significant development. The draft legislation incorporates and addresses many of the representations made in our response to the consultation and throughout the working group meetings held as part of the consultation.
Our initial observations are:
- The ownership condition of the eligibility requirement includes qualifying institutional investors, which should enable the use of the QAHC regime in a broader set of contexts, including direct investment activity by institutions rather than only activity via a (diversely held) fund structure;
- The ownership threshold of 70 percent ‘good’ or ‘Category A’ investors should provide a certain amount of flexibility in relation to investment partners (including corporates) who may not fall within the definition of Category A. We also acknowledge that provision has been made to deal with the catch-up provisions relating to carried interest. However, the threshold may limit activity or cause difficulties for houses which have carried interest and co-investment arrangements;
- The activity condition as currently drafted suggests that there may be a level of diversification required at the level of the QAHC – which would not be appropriate for single asset/target holding structures;
- We understand that the proposed minimum capital requirement of £50 million - £100 million may help provide a safeguard against abuse of the regime. However, a lower threshold or a test at the level of the fund/investor may be more appropriate. For example, many funds may make single investments through a number of AHCs which fall below these thresholds (despite the fund overall exceeding this threshold);
- The inclusion of an exemption for overseas property business and gains is a significant development, and this was a material talking point throughout the consultation period. The inclusion of the exemption opens up the possibility of AHCs being used as property holding companies for non-UK property. However, barriers may still remain, given the widespread use and competitive regime in Luxembourg. The stamp duty treatment could mean multiple layers of transfer tax on disposal of an AHC ‘propco’;
- The inclusion of a broad exemption for share disposals is positive and straight forward. Albeit, certain non-corporate holding structures may be left outside the existing definition. The proposed targeted anti-abuse rule for enveloping of certain assets should also be drafted in such a manner to ensure there are not unintended consequences or uncertainty;
- The exemption from the duty to deduct income tax from interest payments in respect of UK source interest appears broad and without the uncertainty of specific conditions / exclusions;
- The regime being elective and the grouping rules appear to offer flexibility and an appropriate outcome in line with discussions as part of the consultation;
- It is also significant that there has been a departure from the requirement for AHCs to track gains and implement reporting to UK participants. However, we note it is still left open as to how perceived tax avoidance risks relating to conversion of income to capital will be mitigated. The comments on reporting in the consultation document also suggest that there may be some form of monitoring;
- The proposed changes to the rules should facilitate the use of QAHCs as holding structures within credit funds. Relying on the existing tax framework for the taxation of debt in the hands of UK investors is straight forward and aligns with overseas vehicles. There may be a case for further assessing whether in appropriate circumstances (e.g. distressed scenarios) a special set of rules could facilitate capital treatment in the hands of investors;
- The response to the consultation does not comment on VAT; and
- There are many areas which (as noted in the response) are yet to be addressed. It will also be important for the rules and definitions to be worked through in detail in order to assess whether ‘appropriate’ arrangements may fall outside the requirements.
We will be reviewing the proposed arrangements in further detail, and participating in the further round of working group discussion and consultation. We would welcome the opportunity to discuss the developments, and the broader ongoing funds reform in the UK.