Development of the UK Asset Holding Company regime – an update
Update on the development of the proposed UK Asset Holding Company regime following working group discussions with HM Treasury and HMRC.
Update on the development of the proposed UK Asset Holding Company regime following.....
In our article dated 2 August 2021, we provided our initial thoughts on the proposed UK Asset Holding Company (AHC) regime described in HM Treasury’s response to the second AHC consultation document and the draft legislation issued in July 2021.Since then, HM Treasury (HMT) and HMRC have continued to work at a fast pace with the aim of including a full draft of the AHC legislation within the next Finance Bill (expected in the final quarter of 2021) so that the regime may commence in April 2022 as intended. In this article, we provide an update on the key developments in the drafting of the legislation and potential changes or refinements to the original proposals that might be reflected in the Finance Bill.
Since the original announcements in July 2021 (see previous article), HMT and HMRC have continued to engage with stakeholders within the investor, fund manager and adviser community through working groups focussing on key aspects of the legislation and other discussions. Their aim is ensuring that the AHC regime is accessible to investment funds and institutional investors and increases the competitiveness of the UK as a location from which to hold investments. These discussions covered further detailed proposals for aspects of the legislation that were not included in the July announcements and identified a number of difficulties and uncertainties with the original proposals as well as potential solutions.
HMT and HMRC have undertaken to consider all of the issues raised, and in some cases explained their proposed approach to dealing with them, and the direction in which the rules are heading is largely positive.
The key developments to the proposed regime are summarised below.
Eligibility criteria and ownership condition
- The proposal to require a minimum level of capital investment in an AHC in order for it to qualify for the regime as a Qualifying AHC (QAHC) has been dropped, following representations from a number of stakeholders. This is positive given the various reasons/situations in which a UK holding company may not necessarily meet the sort of thresholds that had previously been suggested (£50 million to £100 million);
- There are ongoing discussions regarding indirect investment in a QAHC by a qualifying investor and the ability to ’look through’ certain entities (such as a single investor fund or a 100 percent owned corporate special purpose vehicle) to the qualifying investor for the purposes of satisfying the 70 percent ‘Category A’ ownership requirement. As drafted, it is not clear that certain indirect holdings by qualifying investors would satisfy the requirement and greater clarity has been requested;
- It is also expected that the activities condition will be refined to allow companies holding a single asset to be a QAHC, whereas the current draft legislation requires a QAHC to be used for the purposes of spreading investment risk;
- HMRC are considering requests for further clarity regarding the permitted activities of a QAHC, which the current draft legislation says is not permitted to carry out non-investment activities 'to any substantial extent’. It is crucial that a QAHC is able to carry out the range of functions necessary to demonstrate that it has ‘substance’ and is entitled to double tax treaty benefits in line with international guidance on the Principal Purpose Test; and
- There have also been requests for further clarity and guidance on how the ‘genuine diversity of ownership’ condition should be applied to funds in determining whether or not they are ‘Category A’ investors, as many have not had to apply this condition before, and it will be crucial they can have confidence that they do qualify.
Entry into the regime
- HMT and HMRC are trying to facilitate user-friendly and straightforward entry and exit procedures;
- A two year ‘ramping up’ period is proposed to allow for a period of funding of the QAHC prior to its full investor base acquiring their interests where the ‘ownership condition’ does not need to be met upon the initial establishment of the QAHC provided there is a reasonable expectation that it will be at the end of the period;
- As noted previously, where an existing UK company enters the regime, it will be deemed to dispose of and re-acquire assets which fall within the QHAC ‘ringfence business’ at market value on that date. Where the relevant assets include shares which satisfy the conditions of the UK’s substantial shareholding exemption (SSE), no taxable gain will arise on the deemed disposal of those shares upon entry into the regime, further facilitating the transition of some existing structures into the regime;
- A welcome relaxation is proposed to the normal SSE rules in these circumstances such that if the 12-month holding condition has not yet been met at the time of entry into the regime, the exemption will still apply provided the company continues to hold the shares for 12 months and the conditions of the SSE are satisfied immediately after the end of that 12-month period;
- Where a taxable gain is triggered on entry into the regime (i.e. in cases where the extended SSE conditions are not met) it will not be possible to defer payment of the tax due e.g. until the assets are actually disposed of, as this was thought to introduce too much complexity; and
- HMRC are aware that the entry charge may also prevent certain existing holding companies of non-UK real estate (that are currently located offshore) from migrating and entering the regime and are considering this point further from a policy perspective.
Exit from the regime
- A QAHC may choose to exit the regime and notify HMRC. It will also need to notify HMRC as soon as it becomes aware that it no longer meets one or more of the QAHC ‘qualifying conditions’;
- An exit charge should not arise where a company ceases to be a QAHC and exits the regime. In addition, on exit, all assets within the AHC regime would be rebased to their market value on exit, so that any appreciation in their value during their time within the AHC regime would benefit from its time in the regime and remain exempt from tax;
- A two year ‘winding down’ period has been proposed to allow for the potential breach of the ‘ownership condition’ as a fund winds down at the end of its life, provided the QAHC notifies HMRC at the commencement of this winding down period;
- More generally, HMRC are proposing to take a pragmatic approach whereby an AHC won’t necessarily be forced to leave the regime as a result of a temporary breach of the activity or ownership conditions provided certain conditions are met; and
- It is encouraging to see that ‘forced’ exits from the regime (e.g. as a result of the investor ownership base falling below the eligibility levels) should not give rise to a tax charge on gains accrued up to that date.
- HMRC have confirmed that they intend to extend the interest withholding tax (WHT) exemption to most payments made by a QAHC (so the exemption will not be limited to interest paid to those with a relevant interest in the QAHC as originally proposed). We are yet to see more detail on this proposal, but it would be a welcome extension of the position set out in the initial draft legislation, which went most of the way in providing a simple, unqualified interest WHT exemption; and
- The draft legislation includes provisions to prevent interest payments by a QAHC on results dependent securities from being classified as distributions and hence non-deductible. It remains to be seen whether requests for further provisions to ‘turn off’ the distribution rules in respect of convertible securities (commonly used in credit funds) and interest in excess of a ‘commercial rate of return’ will be accommodated, although HMRC expected to be able to address the latter in guidance.
Several other aspects of the proposed regime were discussed, which included:
- Further detail on the ‘ring-fencing’ of the business and assets of a company that qualifies for the QAHC regime including;
- Ring fencing of qualifying business and assets within a QAHC (if it also carries on non-qualifying activities)
- Separate grouping of a QAHC from other companies in their corporate group for group relief, capital gains and corporate interest restriction (CIR) purpose
- Transfers of assets between a QAHC’s qualifying and non-qualifying businesses; and
- The limitations of the proposed gains exemption when it comes to vehicles that do not have ‘relevant shares’, such as trusts.
Our thoughts on progress to date
We have not yet seen draft legislation which captures all of the points raised above, and a number of areas are subject to further consideration before legislation is drafted or amended. These include proposed anti-avoidance rules to mitigate the risk of the roll-up of income in an AHC and conversion into capital returns for investors and provisions intended to ensure an appropriate tax treatment for ‘non-dom’ investors.
HMRC are aiming to share a more comprehensive draft of the AHC legislation with the working group later this month to test the proposed changes and solutions to these issues. The intention is that the legislation incorporated in the next Finance Bill will be comprehensive and enable the regime to work as intended from day one. HM and HMRC have also been clear that they understand the need to support the regime through implementation to ensure it delivers the desired outcomes.
Although work remains in progress on a number of important aspects, and various details need to be ironed out, the overall direction of travel is positive. If the issues identified are addressed appropriately the AHC regime will likely make the UK a much more attractive location for investment holding companies than it has been in the past relative to other more commonly utilised holding jurisdictions.
The proposals are a significant development and asset managers and investors are expected to be able to start using the QAHC regime from next year. The ability to use UK structures is expected to create operational efficiencies and help navigate substance requirements. Investors and asset management groups should consider the benefits of relocating and establishing UK structures.
The reforms are the first part of a broader strategy for UK investment management with the intention of maintaining and developing the UK’s position as an international financial centre. The reforms build on the recommendations made by an Investment Association working group in a 2019 report to the HMT Asset Management Taskforce. HMT has also opened a ‘Call for Input’ into UK fund structures covering tax alongside legal and regulatory matters. An update is expected soon. As a consequence of the reforms we anticipate that UK funds and holding structures will become more prominent across alternative asset classes.