New Tax Rules Aim To Level Playing Field for UK Investment Holding Companies
On April 1, 2022, new rules designed to make the UK a more attractive jurisdiction for holding companies came into effect. The new Qualifying Asset Holding Company (QAHC) regime could result in a more favourable tax environment for private equity firms with a strong presence in the UK – in line with the likes of Luxembourg and Ireland – just as planned legislation threatens to set a higher bar for sponsors to access tax treaty benefits in the EU.
However, there remain some potential arguments against the UK QAHC regime including barriers to entry; questions about qualifying activities; and administration issues. So, why was the QAHC regime introduced and what are the pros and cons for private equity sponsors?
A New Regime of Tax Benefits
The QAHC regime is part of an array of measures aimed at making Britain more competitive after Brexit. The QAHC regime represents a concerted push to encourage sponsors to keep assets onshore, by levelling the tax playing field with other common jurisdictions for private equity, as well as some other alternative investment holding companies.
Some of the key measures of the new regime include:
- A simple exemption from tax on capital gains which stem from the disposal of company shares. This is an improvement on the former conditional exemption, which sits alongside an existing exemption in relation to dividend income
- A blanket exemption from the 20% UK withholding tax on interest
- The removal of a number of rules limiting interest expense deductions
- Making it easier for UK tax residents to realise gains on company investments as capital rather than income
Why the UK Could be the Right Choice for Holding Companies
Private equity sponsors with offices and operations in the UK may find it easier to prove substance in the country than in competing offshore jurisdictions. In recent years, EU tax authorities and tribunals have been more strict on access to double tax treaties and EU tax directives on the basis of insufficient substance. The third iteration of ATAD (Anti-Tax Avoidance Directive), which is currently in the proposal phase and aims to crack down on shell companies, could further raise the bar on proving substance by focusing on requirements such as local administration, personnel and premises.
The professional services provider community may also give the UK an edge, as may some aspects of English corporate law – which in some areas, like corporate governance, can be notably more flexible than in countries like Luxembourg. In addition, there is flexibility that can permit a UK tax resident QAHC to incorporate in a non-UK jurisdiction, such as Jersey or the Cayman Islands.
What Could Make UK QAHC Less Attractive for Sponsors?
Restrictions or pitfalls under qualifying condition tests could present a barrier for some private equity funds. Indeed, qualifying conditions require QAHCs to be owned by institutional investors or widely held funds, applying various tests, some of which are complex.
Specific types of sponsors could also find rules on QAHC qualifying activities unclear. The QAHC regime only applies to companies whose main activity is investment. This could create uncertainty for private equity sponsors that operate within the credit market, covering loan origination or debt restructuring. Helpfully, HMRC has recently updated its guidance on these kinds of activities providing more comfort – subject to testing on a case-by-case basis – that many credit fund activities will qualify.
It is also worth noting that UK real estate does not count as a qualifying investment.
Administration and reporting for QAHCs could be seen as a drawback. Companies must take reasonable steps to monitor whether ownership conditions continue to be met, and they must also provide financial information on an annual basis to HMRC, including estimates of the value of in-scope assets.
For sponsors that have asset holding companies which fall clearly within the new regime, and who do not have a well-established holding company platform in European jurisdictions like Luxembourg, there are clear benefits with the QAHC regime. QAHCs can work equally on an asset-by-asset basis for sponsors, as well as for the investments of a particular fund. Whether there will be wholesale adoption of the regime by private equity firms remains to be seen. Adoption may be piecemeal until market practice develops and some sponsors may wait for the outcome of the ongoing wider review of UK funds regulation and taxation.
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Richard Sultman is a Partner at Cleary Gottlieb Steen & Hamilton LLP
Michael James is a Partner at Cleary Gottlieb Steen & Hamilton LLP
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The views expressed in this article are those of the author and do not necessarily reflect the views of AlphaWeek or its publisher, The Sortino Group
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