Prompt tweaks to the qualifying asset holding companies regime
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The UK’s qualifying asset holding company (QAHCs) regime has been in force for little more than a year (it was introduced by the Finance Act 2022 with effect from 1 April 2022). However, in its recent Finance (No. 2) Bill 2022/23, published on 23 March 2023, the UK government has already proposed a number of amendments, tweaks and clarifications.
The QAHCs regime constitutes one of the government’s first substantive efforts to attract further investment to the UK in a post-Brexit environment. The regime is designed to facilitate investment by reducing tax friction; broadly, the intention is that investors should be taxed no less favourably than had they invested in the underlying assets directly. The UK hopes that the regime will offer a useful alternative to the Irish and Luxembourg holding company regimes, and it is expected to be particularly useful in contexts in which there is already a UK nexus.
Early indications have elicited considerable interest from private capital and other investors. Further, the government is clearly still in listening mode and the most recent changes, which we outline below, are largely favourable to the funds industry, offering additional flexibility to the conditions that must be satisfied in order for a company to benefit from the regime.
The ownership condition: changes to meaning of ‘genuine diversity of ownership’
Arguably, the most significant of the proposed amendments relates to changes to the genuine diversity of ownership (GDO) requirement in the context of the ownership condition.
Broadly, the ownership condition requires that the total proportion of relevant interests held by persons who are not Category A investors (‘good investors’) must not exceed 30%. Category A investors include ‘qualifying funds’; these include collective investment schemes satisfying a genuine diversity of ownership (GDO) test, which is focused on the way in which the fund is marketed. There are other ways of qualifying as a qualifying fund, but the very significant, practical advantage offered by the qualifying fund/GDO route is that it is a ‘once and for all test’. That is, there is no ongoing requirement to monitor percentage of relevant interests, an exercise that requires analysis of both legal and beneficial interests and is not always straightforward.
However, the existing rules contemplate that the GDO requirement can only be satisfied on an entity- by-entity basis. By contrast, the amended rules (which will have effect from royal assent to the Finance (No.2) Bill 2022/23) will permit multi-vehicle arrangements to satisfy the GDO requirement where an investor in one of those vehicles would ‘reasonably regard that investment as an investment in the arrangements as a whole’. The effect of the amendment is therefore to enable certain parallel, feeder and aggregate funds to meet the GDO condition where this might not otherwise have been possible. Further, the wording of the draft legislation is wide enough to permit additional vehicles to be added to the arrangement at a later date (although it will be important to ensure that the marketing documentation anticipates the full range of investment).
This additional flexibility is likely to be a very significant improvement in the regime for a number of investors, and we have seen advantages particularly where a range of investor profiles is allocated to separate funds but where commercially all of the investors would see themselves as investing in the same fund. By way of an example of where this might be relevant, some investors want fund structures to be fully transparent for US tax purposes whereas others would suffer adverse consequences if they invested in a transparent structure, so it is common to have feeder vehicles that can act as a US tax ‘blocker’ for those investors. Similarly, the ATAD 2 anti-hybrids rules can mean that for some Luxembourg funds it is important to bring in investors from certain jurisdictions through corporate feeder structures.
It is important to note that QAHCs are not the only UK tax regime to be affected by tweaks to the scope of the GDO test. The term is also relevant (and the draft legislation includes equivalent amendments to) the GDO condition that applies in the context of REITs and UK property rich investment companies. Changes to these regimes might also be considered to be part of the government’s ongoing commitment to bolster the UK’s fund industry.
Other changes in the Finance (No.2) Bill 2023 (discussed below) are specific to the QAHC regime only.
The ownership condition: corporate funds
As mentioned above, the qualifying fund/GDO route to satisfying the ownership condition requires the company to constitute a collective investment scheme. The effect of this, under the existing legislation, is to preclude bodies corporate, or entities which are treated as bodies corporate by HMRC, from meeting the conditions for QAHC status. In a further welcome development, the draft legislation expands the definition of collective investment scheme for this purpose to include corporate funds and the change is backdated to 1 April 2022. The use of corporate fund vehicles in Luxembourg is increasingly common, again in part in response to the impact of ATAD 2.
Changes to the investment strategy condition
There are also changes to the investment strategy condition, which currently stipulates that a QAHC’s investment strategy cannot include the acquisition of listed or traded securities (or derivative interests thereof) except in certain narrowly defined circumstances.
The draft legislation offers new flexibility by permitting a QAHC to elect to treat listed securities as unlisted for these purposes. However, dividends from securities in respect of which an election is in place will be taxable. This has the effect of undoing the exemption for distributions that would otherwise apply, so a company will want to consider carefully the relative merits and demerits of its proposed investment strategy in any particular case.
Relationship with securitisation regime
The draft legislation will also enact an express prohibition on securitisation companies being QAHCs with effect from 15 March 2023. This is an interesting area which has been the subject of some recent technical industry discussion. Companies taxed under the Taxation of Securitisation Companies Regulations, SI 2006/3296 (‘the securitisation regime’), are subject to a standalone tax regime which broadly looks to tax residual profit on a simplified basis. Prior to the introduction of the QAHC regime it was not uncommon to see the securitisation regime used in the context of debt funds (that is, outside the context of securitisations in their conventional sense). For a number of reasons, it may in any event have been difficult to contrive for a company to fall within both the QAHC and the securitisation regime. However, it might have been possible in theory. The draft legislation ensures that there is now a straight choice between the two regimes.
And finally, the draft legislation also includes a series of amendments to the QAHC regime which are intended to ensure that the legislation works ‘as intended’. These include provisions which ensure that alternative finance arrangements can constitute relevant interests in appropriate cases and the inclusion of derivatives within the exemption from chargeable gains for a disposal of qualifying shares. An anti-fragmentation rule will be extended to excluded structures comprising more than one QAHC in which the combined percentage of relevant interests not held by category A investors exceeds 30%. These might be considered to come under the heading of ‘tidying up’ and are largely clarifications of the intended position.
The funds industry and its stakeholders will no doubt be pleased with the collaborative and engaged approach shown by the government in its proposed revisions to the legislation. The prompt arrival of these reforms might be interpreted as a demonstration of the government’s continuing commitment to energising the funds industry. Certainly, it portrays a government still very much in listening mode. It might also be taken to be an indication of the degree of industry interest in the new regime.
There is much to be positive about in the context of these proposed legislative changes. However, arguably the industry is still waiting for the final piece of the funds tax jigsaw: the VAT treatment. The government’s long-awaited consultation on the VAT treatment of fund management services was finally published in December 2022, and an official response document is pending. It is generally expected that the outcome will be codification, rather than wholesale change. Nonetheless, practitioners will no doubt be pleased to have some finality in this respect, even if some of the most optimistic demands as to the treatment from the funds industry now seem unlikely to materialise.
This article was first published in the 11 May 2023 edition of Tax Journal.