UK Funds: New Tax Regime for UK Asset Holding Companies
In private equity, the Fund vehicle is typically a limited partnership, which is tax transparent for most investors (indeed an investor treating the Fund vehicle as opaque creates all sorts of challenges for many Funds pursuant to anti-hybrid rules).
It is common in most types of Funds, except where tax transparency is desirable, for the Fund partnership to incorporate a holding company. This shields investors from direct receipt of the Fund’s income and gains (and corresponding tax leakage) and helps ring fence risk. Other than tax leakage at the level of the underlying SPVs, most of the tax risks in the Fund, such as corporation tax on income and gains, and withholding tax on interest and dividends, will then sit at the level of the asset holding company held directly by the Fund partnership (for VAT on management fees, see further below).
Therefore the choice of jurisdiction for the asset holding company is crucial to help mitigate tax leakage, and in order to maximise returns to investors.
From a tax perspective, the UK as an asset holding company in a Funds context has lagged behind other Fund friendly jurisdictions such as Luxembourg. Until now.
Further to two consultations, the UK government has published draft legislation setting out far reaching reforms to the tax treatment of qualifying UK-resident asset holding companies (QAHCs) in alternative Fund structures (further information can be found here) (QAHC Tax Proposals). The new regime is intended to apply from 1 April 2022 (for corporation tax, stamp duty and SDRT purposes) and 6 April 2022 (for income tax and capital gains tax purposes). These changes are part of a wider review of Funds tax which is likely to see improvements to the UK’s Funds tax regime, and make it a more attractive location.
Very broadly, the QAHC Tax Proposals looks to create a bespoke UK tax-friendly regime for QAHCs, in order to try and encourage Fund managers to set up their Fund structures and asset holding companies in the UK.
The QAHC Tax Proposals go further than many had expected when the first consultation was published, and in some respects the regime will be even more favourable than the tax regime in Luxembourg, as the proposals contain the following:
- a comprehensive capital gains tax exemption on the sale of shares and non-UK real estate, and without minimum holding requirements as are required in other jurisdictions such as Luxembourg;
- no UK withholding tax on interest to shareholders, and under existing UK law there is no dividend withholding tax for dividends paid by UK companies (other than e.g. UK REITs);
- interest deductions will be available on profit participating loans; and
- share buybacks from the QAHC will be made much easier, and this will allow capital to be repatriated to investors and carry holders with minimal tax leakage, including exemptions for stamp duty and SDRT.
Please see below a more comprehensive list of the proposals. It should be noted that the rules for the taxation of UK real estate, and direct and indirect disposals of UK real estate are not affected.
However, other than tax at the asset holding company level, there are still two important issues that the UK government should look to resolve, in order to allow the UK to seriously compete with Luxembourg and other Fund friendly jurisdictions:
- UK VAT : a UK AIFM supplying management services to a UK Fund (i.e. for VAT purposes to the UK resident General Partner of the Fund (“UK GP”)), will, in most cases be subject to 20% UK VAT. Generally, a UK GP of a Fund which holds shares will not itself be making taxable supplies, and this could lead to irrecoverable VAT at 20% at the level of the Fund, thereby increasing the management fee by a cost of 20%, unless care is taken. There are practical solutions, such as VAT grouping the UK AIFM and the UK GP which is common in many UK Fund structures (and HMRC have announced no changes to the VAT grouping rules affecting limited partnerships, following the recent call for evidence), but this is not as straightforward as a UK advisor providing services to a Lux AIFM which is not subject to UK VAT, and the UK advisor should be able to recover its input VAT (and in some circumstances there may be no Luxembourg VAT). Helpfully, we also note that the HM Treasury have been considering how VAT impacts Funds pursuant to a separate consultation, and possible changes, such as expanding the scope of the investment management exemption, should hopefully provide further certainty to Fund managers.
- Post-Brexit regulation - marketing to EU investors : this is more difficult for the UK government to resolve. Post-Brexit there continue to be significant regulatory hurdles to a UK manager marketing to EU investors. The lack of ‘passporting’ rights means that UK regulated managers are unable to market to EU investors, and relying on ‘reverse solicitation’ (i.e. whereby the EEA investor approaches the UK manager without any prior communications) or going via the National Private Placement Regime is becoming increasingly challenging (see further below).
At the same time, given that the UK tax position has greatly improved pursuant to the QAHC Tax Proposals, a UK management team with its own UK AIFM looking to launch a UK or global Fund, with a relatively small percentage of EU investors, should now think very carefully about establishing a UK Fund and incorporating a UK QAHC to hold the underlying investments.
Please see these proposals below in further detail.