Will UK asset holding companies be coming home?

The UK government is progressing with legislation to take effect in April 2022 aimed at making the UK a more attractive location for asset-holding companies (AHCs). Should UK fund managers with EU AHC operations move their operations to the UK, with the benefits of the legislation outweighing the increased AHC substance requirements in the EU?

A key goal of the government’s funds review, commenced last year, is to boost the UK’s reputation as a funds domicile. The government wants to address the challenges that may lead companies to be located outside of the UK, “despite the UK’s wider strengths as a financial services location and the commercial benefit that funds see to locating these companies alongside UK fund management functions”.

The challenges are associated with funds commonly operating via a tax-transparent vehicles that pool investors but establish non-transparent AHCs to hold investments. Institutional and other tax-transparent investors have an expectation that fund AHC solutions will not affect them more adversely compared with investing directly.

For many UK managers, the pendulum had swung to EU locations, often Luxembourg and Ireland, as AHC jurisdictions of choice, given their straightforward solutions in addressing the challenges. For example, when a Luxembourg-established AHC sells an asset, it is relatively easy to access the Luxembourg participation exemption to prevent tax arising on any capital gain which is realised. In addition, no tax is payable when sale proceeds are distributed to a fund’s investors.

“UK managers’ decisions may be dominated in the future by more stringent EU substance requirements”

The UK government has constructively engaged with fund managers and other stakeholders, and announced legislative reforms that mean there will be a new category of UK resident unlisted qualifying asset holding company (QAHC) which needs to be at least 70% owned by diversely owned funds, or pension funds and certain other institutional investors.

The principal benefits of QAHCs aim to ensure that most income and gains will be returned to investors without UK tax being paid on those amounts by the QAHC. For example:

• A capital gains exemption on disposals of shares, and gains on disposals of non-UK real estate (shares in companies deriving at least 75% of their value from UK real estate are disqualified);
• An exemption for profits from a non-UK real estate business where those profits are subject to tax in a non-UK jurisdiction;
• Deductions for certain interest payments that would usually be disallowed as distributions – for example, payments on profit-participating and results-dependent loans;
• No withholding tax on payments of interest in respect of securities held by investors in a QAHC.

Investment activities will be categorised as either qualifying or non-qualifying, with ring-fencing rules ensuring that only qualifying activities will attract the benefits of the new regime. There is a prohibition on other activities, which includes trading activities and investing in UK real estate. The QAHC cannot also operate as a UK real estate investment trust.

An elective regime applies. An elected QAHC is treated as disposing of and re-acquiring the assets relating to its qualifying activities on entry into the regime – that is, for UK tax purposes, rebasing the assets to market value and triggering any latent gain with a mirrored rebasing on exit from the QAHC regime.

Continue with EU AHCs or operate UK QAHCs?

UK fund managers will need to decide between continuing with EU AHCs or taking up QAHCs – a decision linked to addressing AHC substance requirements in the EU AHC scenario. For instance, a Luxembourg AHC may seem more attractive from an operational perspective because it is more straightforward compared with the relative complex QAHC requirements. As an example, QAHCs require compliance with eligibility criteria when no such criteria apply to Luxembourg AHCs.

The UK government has an understandable concern to protect the Exchequer and minimise the risk of tax avoidance. An example is the government stipulating that transaction tax applies on purchases of shares or other securities issued by a QAHC (the exception being when the QAHC repurchases its own shares or debt securities). By contrast, Luxembourg does not levy a transaction tax in comparable situations.

However, UK managers’ decisions may be dominated in the future by more stringent EU substance requirements, which result in the pendulum swinging towards the UK QAHCs.

EU AHC substance requirements

Fund managers must monitor their future EU AHC arrangements given European court decisions tightening interpretations of substance requirements and the European Commission’s plans for legislation in 2022 to ensure EU AHCs should not operate as shells to avoid tax.

The Commission announced the EU’s new business tax agenda in May 2021, which includes tackling the abusive use of shell companies – meaning companies with no or minimal substantial presence and real economic activity – and denying those companies tax advantages. After the details of the legislation become available (which are expected later this year), UK fund managers must assess whether their EU AHCs will maintain satisfactory substance and real economic operations such as employees, turnover, premises, responsibilities and risks being undertaken.

UK fund managers – and their fund investors – might decide to avoid the EU substance scrutiny (and risks to their fund structures on account of this legislation) and instead opt for UK QAHCs. They may prefer the robust solution of the UK as a single jurisdiction for their combined fund and AHC operations. Looking to the future direction of the EU Commission’s tax policy, this solution may be a greater priority than the operational merits of the EU AHCs (compared to the QAHCs).

The QAHC regime and the EU’s shell company legislation could facilitate the trend of UK AHCs coming home.