Proposed new UK asset holding company regime

Earlier this week the HM Treasury published a consultation document (the Condoc) containing proposals for a new tax privileged regime for asset holding companies (AHCs) used in alternative fund structures (the Proposals) and held two "town halls" where they were discussed with various interested parties, including industry bodies, ourselves and certain other professional advisers.

The Proposals follow on from a consultation held earlier this year, in which the Government acknowledged certain tax factors that currently make the UK a less attractive jurisdiction for locating AHCs than, for example, Luxembourg and sought views as to how the position can be improved.

The Government is looking to make the new regime work so that it has, both, tax efficiency (i.e. minimal tax leakage (with the aim being that investors are taxed, broadly as if they had held the asset directly)) and, just as crucially, is simple to use. However, this element of simplicity may be hard to achieve, with the Government being wary that the rules would be misused and, consequently, seeking, at present, to build in complex eligibility criteria, anti-avoidance measures and potential streaming. An interesting dynamic will be, therefore, the extent to which HMT is able to resist the tendency to complexity and instead create a regime with the technical and operational simplicity that the industry wants.

The process is still at a fairly early stage, with the Government suggesting a number of options. Helpfully, it is very much in listening mode as to how the new regime could best be designed.  The consultation will run until 23 February 2021, with our understanding being that the Government is looking to publish a first draft of the legislation for consultation in the summer with a view to enactment in 2022.

We set out below a high level summary of key aspects of the Proposals.

The Government believes that the rationale for bespoke rules for AHCs is clearest in structures where capital from diverse or institutional investors is pooled and managed by an independent, regulated or authorised asset manager, in which the AHC plays an intermediate, facilitative role. It is, therefore, looking to design rules that contain the following four sets of criteria.

1. Criteria for investors

Here, the intention is, essentially, that the rules should not apply in relation to funds or companies controlled by a small number of persons, such as members of a family or companies in common ownership.  The Condoc sets out the following two possible approaches.

a) The regime could require that an AHC be wholly owned by a fund or number of funds that are each either a Collective Investment Scheme (CIS) or an Alternative Investment Fund (AIF), as defined for the purposes of UK regulation – with the Government also (importantly) considering including REITs and their overseas equivalents.

HMT are aware that this will not necessarily ensure that the fund is not controlled by a small number of investors other than institutional investors and, so, is considering whether the regime should also require that the fund vehicle either:

• meet a "non-closeness" or the "genuine diversity of ownership" test, or
  
  
• be unable to meet either of those tests only because it has one or more "qualifying investors" (perhaps using a similar definition to that in the non-resident CGT rules, so including certain institutional investors, such as pension funds).

HMT recognise that this would not address the situation where persons other than relevant funds hold stakes in AHCs (e.g. if fund managers co-invest at AHC level rather than through the fund). They are seeking views on whether and how to address this. This could be done via the second approach (see the next section below).

b) The regime could look directly at investors’ interests in the AHC itself to determine whether it was set up to benefit diverse or institutional investors (rather than requiring that the AHC be owned by a fund set up for that purpose). This might mean that a company could only qualify as an AHC if it is "non-close" (or is only close because it had one or more owners who was within a category of permitted investor e.g. a qualifying investor).

HMT recognise that there could be significant complexity involved in attempting to apportion the effect of AHC rules so that they were only available to some owners. Therefore, if the regime accommodated owners other than funds, this might mean that all owners could access its benefits, whether or not they invested via a separate fund vehicle.

2. Criteria for identifying investors

Here, HMT are looking to determine the investors in an AHC using a test that is consistent with the commercial reality of the arrangements. They anticipate that, broadly, a person making investments via an AHC will be a person who has an interest in and participates in the results of investment assets that the AHC acquires. This would mean lenders who advance fixed rate loans would not be relevant investors, whereas those who advance ones with a results dependent interest rate would be.

3. Criteria for management

HMT propose that an AHC should sit within an investment structure that uses an independent asset manager who provides investment management services, including managing fund assets, in return for an investment management fee. HMRC clarified, informally, that this meant independent from the investors.  

The Proposals, therefore, consider how to identify what constitutes a manager (e.g. is it the person that contracts to perform portfolio and/or risk management with regard to the AHC's assets?) and what requirements that person must meet. On the latter point, HMT propose that investment assets held by an AHC should be managed by an undertaking that is authorised or registered for the purpose of asset management, subject to supervision in their jurisdiction and independent of investors. HMT appear to recognise there should be an exception from the independence requirement for carried interest and management coinvestment, but intend that it be subject to a cap. A question here is how this rule would be adapted to operate for internally managed structures also.

4. Criteria for the character and activities of the AHC

HMT want to restrict the regime to entities that serve to facilitate flows of capital, income and gains between investors and investment assets. The Condoc sets out different ways of achieving this and seeks views on them.  An aspect of this is whether there should be a prohibition on trading. Issues with such an approach include that the question of whether a company is trading is often hard to apply and that not all other jurisdictions make this distinction. As, in the UK, whether a company is trading will depend very much on what the company actually does in practice, this cannot always be conclusively assessed upfront, when a fund may be deciding where to locate its AHCs, thereby reducing certainty and adding complexity to the regime.

Income profits

These will be taxable but, crucially, such taxation should be proportionate to the AHC's role. HMRC anticipates that, typically, this will be fairly limited and not require much activity by the AHC (of course in practice this may not always be the case).

An issue here is how the level of taxable profit can be managed to ensure that it is at the appropriate, proportionate level. Helpfully, HMT is considering allowing deductions for profit-dependent interest, but it is also looking at wider ideas, so that the desired result can be achieved without being tied to a particular sort of instrument (e.g. allowing AHCs to get tax deductions for any distributions other than dividends). HMT is also seeking views on how to ensure that profits are not reduced below the proportionate level, including on the appropriateness of transfer pricing type principles and with a view of ensuring that potential treaty access is preserved.

HMT recognise that the special rules for AHCs could potentially be subject to the UK's anti-avoidance rules applying to hybrid mismatches. Helpfully here, the Condoc confirms that it is intended that they will be disapplied, to the extent needed to meet the policy objectives of the AHC regime. Good news!

Capital gains

AHCs will have a new relief for gains on disposals of investment assets, (other than UK land or assets that derive 75% or more of their value from UK land (UK Property Rich Assets), which will be considered further), such that there should be no tax on gains generally at AHC level. Non-UK investors should receive such gains free of UK tax, as at present.

HMT anticipate that gains that are not reinvested will be taxed when returned to UK investors (or those investors will be taxed when they dispose of their interest in the AHC). Here, it is interested in views as to the risk of AHCs being used to artificially roll up gains in the vehicle

Withholding tax on payment of interest to investors

HMT is considering introducing an exemption for loans from investors to AHCs from the requirement to apply 20% withholding tax (WHT) to payments of interest. As, in practice, funds can generally obtain relief or an exemption from UK WHT, the benefit of a bespoke exemption is likely to be the cost saving associated with removing the administrative burden of structuring arrangements needed to fall within the existing reliefs and exemptions. 

HMT are considering whether anti-avoidance provisions need to be built into the exemption to prevent misuse. However, given that it is currently possible to structure arrangements so that no WHT arises, it is hard to see what such provisions would achieve

Income and gains paid to investors

Under the Proposals, amounts deducted from taxable income of an AHC and paid to investors within the scope of UK tax would be treated as taxable income in the hands of those investors, whereas amounts returned to such investors that are attributable to capital gains realised by an AHC would be treated as gains in the hands of those investors.

Whilst variants of this income treatment already exist in the UK tax code (for example, deductible interest distributions paid by authorised bond funds), streaming underlying capital gains in the way proposed is more novel and so the Condoc discusses a number of different design ideas.

Stamp duty and SDRT

HMT intends to explore providing an exemption from stamp duty exemption where an AHC repurchases its own shares in order to return capital to investors and, more generally, HMT will explore whether there is scope for broader exemption from stamp duty and stamp duty reserve tax (SDRT) on some or all transfers of shares and loan capital in an AHC.

Reporting

Under the Proposals, for a company to qualify as an AHC for an accounting period, it will need to make an election as part of its company tax return. In addition, as an additional element to that return, in order to enable the Government to monitor the regime, it is proposed that AHCs will be required to provide a specified set of information.

Real estates and AHCs

Real estate seems to be a particularly tricky area for HMRC, especially given the existing complex regimes that already exist for the taxation of UK property income and gains, plus the separate REIT rules and the collective investment vehicle rules that form part of the non-resident CGT regime.

The Government wants to ensure that it retains its taxing rights over income and gains derived from UK real estate. One potential approach the Condoc seeks views on as a means of achieving this, is simply not permitting an AHC to hold UK land or UK Property Rich Assets. In the context of using the AHC as a vehicle for global or international investment, helpfully, HMRC seem to be moving towards a position that AHCs should be able to hold UK Property Rich Assets through a corporate vehicle.

The Government appears prepared to accept that gains derived from non-UK real estate should not be taxed within the AHC (so that, ultimately, only UK taxpaying investors pay tax on them when the proceeds are returned by the fund or they dispose of their interests in the fund). This should be achievable through the general exemption for tax on gains realised by AHCs, though streaming may be required here to the extent that there is UK real estate in the structure.

The position for income from non-UK real estate if it is to be allowed to be held directly is, again, complex, as such income is likely to be subject in any case to local tax where the property is situated. Some respondents to the initial consultation had suggested that AHCs simply be exempt from UK tax altogether on this income. While from the town halls it seems that this is not the Government's preferred route and that they would prefer the AHC to rely on the current rules that allow UK companies to claim tax relief on foreign property income that has been subjected to local tax, they are happy to take more anecdotal evidence, as to how this works in practice. Should HMT not move on this one, it is unclear the extent to which HMT envisage limiting the UK income taxation of an AHC by reference to the role it actually performs in this situation. Given the aim for a simple regime, we are expecting to see some representations on this.

REIT reforms

In parallel with the new AHC regime, the Government is also considering prioritising some targeted reforms to the UK REIT rules. This is to remove some of the immediate barriers to entry and facilitate its use as an asset holding regime for certain investors.  The timescale envisaged for this is similar to that proposed for the new AHC regime, with a comprehensive review of the REIT regime to follow, as part of the wider funds review.

The key proposals – the result of much discussion with the industry – are:

• to widen the list of eligible institutional investors – relevant to meeting the non-close requirement. This is likely to follow more closely that used for the non-resident CGT rules.  However, this is likely also to see an inclusion of a widely held rule within the definition of institutional investor, which may in fact limit the eligibility of certain investors;
  
  
• to change the test for assessing whether a non-resident person is equivalent to a UK REIT. This is relevant as such a person is an eligible investor for the purposes of non-close requirement. Currently the test requires that person to be equivalent to a UK REIT under an equivalent regime in that person's tax jurisdiction but the Government is considering modifying this so that it suffices that the overseas entity would qualify as a UK REIT were it to be UK resident;
  
  
• the option of an unlisted REIT for certain investors. UK REITs listed on an exchange outside the UK have become increasingly popular amongst institutional investors, in particular, as a joint venture vehicle, when the relevant investors are not, for example, seeking the benefits of potential liquidity etc that is otherwise associated with listing. Importantly, it is not being proposed, however, that making listing optional will be open to all UK REITs, but only where certain eligibility requirements are met as to the investor base. Quite what these are is subject to the consultation;
  
  
• relaxation on the, effective, restriction on payments of dividends to corporate shareholders holding an interest of 10% or more in UK REITs, so that it only will apply to those who are not entitled to gross payment.  This will be very good news for many UK corporate groups who, to date, have had, in practice, generally had to disaggregate their interests amongst one or more subsidiaries to avoid breaching the threshold. Such a change should be of particular interest to UK life companies, for whom disaggregation is not usually an effective solution.  The rule would still, however, be likely to apply to non-resident companies, given the need for protection of the Exchequer in the application of double tax treaty reliefs, which was indeed its original purpose; and
  
  
• a widening of the 75% balance of business test to offer more flexibility in compliance, given the need to cater for exceptional events and changes of circumstances.

The comprehensive review of the REIT regime (mentioned above) should consider other aspects of change that REITs would like to see.  One point which will, no doubt, be picked up here – if not part of the main AHC consultation -will be rules to facilitate and improve the position on investment by UK REITs outside the UK.