UK reforms could make vehicles attractive to UK pension funds and international investors, writes Melville Rodrigues
From this April there are attractive opportunities for fund managers – particularly those based in the UK – with the UK government implementing two reforms that enhance the UK’s attractiveness as a location for asset management:
Qualified asset holding companies (QAHCs)
Managers commonly adopted EU – primarily Luxembourg – holding companies, but this practice needs to be reviewed given the EU’s proposed ‘unshell’ requirements for greater substance to tackle “the misuse of shell entities”. UK managers may prefer the safer option of QAHCs based on their UK operations – the robust solution of the UK as a single jurisdiction for their combined fund and QAHC operations.
QAHCs are attractive for holding non-UK real estate as there can be significant tax benefits, including the exemption of capital gains (including gains on qualifying shares), on non-UK real estate and profits of a non-UK real estate business where those profits are subject to tax in a non-UK jurisdiction. To be eligible, QAHCs need to be at least 70% owned by diversely-owned funds, or pension funds and certain other institutional investors.
Real estate investment trusts (REITs)
These vehicles can now be unlisted, provided institutional investors hold at least 70% of the ordinary share capital. REITs are tax exempt on profits (both income and capital gains) arising from carrying on a qualifying UK property rental business. Investors’ tax liability replicates the scenario under which investors hold investments directly – treated as property income distribution (PID), subject to withholding tax of 20% or (with international investors) may effectively be lower under applicable double-tax treaties.
In addition, the definition of the holder-of-excessive-rights (HoER) tax charge has changed. REITs are no longer subject to the HoER penalty charge (that applies to distributions to a company/body corporate that is beneficially entitled to 10% or more of the REIT’s distributions or share capital, or controls 10% or more of its voting rights) where PIDs are paid to shareholders entitled to gross payment like UK corporates. This avoids the need for those investors to fragment their interest.
The reforms of both QAHCs and REITs could be particularly attractive for UK pension funds and other tax-exempt institutional investors. For instance, QAHCs avoid the ‘unshell’ risk and REITs facilitate diversified returns via a UK corporate structure that does not incur a UK corporation tax trap – significant with the tax rate increasing to 25% from April 2023. REITs could also appeal to international investors given the scenario that the withholding tax on the annual REIT distribution (taking into account double tax treaties) could reduce to 15% – a 10% differential when compared to the 25% corporation tax rate.
In addition, the REIT now has the flexibility to operate as a tax-efficient joint venture or ‘club’ that competes with offshore alternatives.
Managers are encouraged to explore and understand these transformative reforms as the UK reinforces its global leadership as a funds centre of excellence.