The UK government recently released a response document and draft law following a second consultation exercise on what are now called Qualified Asset Holding Companies (QAHCs). This is aimed at the introduction of a new tax-advantaged UK intermediary company which could be used by investment funds as a means of investing in underlying assets. It is designed to be competitive with existing regimes in the EU such as Luxembourg. See our previous OnPoint for more details on the first consultation exercise and the first response document here. The intention is that the new QAHC regime will come into effect from April 2022. Although this initiative is proposed to apply to a wide range of investment funds, this OnPoint is designed to focus on impact potential of the proposed rules for alternative credits / debt funds.
It can be useful to illustrate new proposals and outstanding issues through a straw credit fund structure.
The structure is a simplified version of how a typical European fund might be established in Luxembourg, where currently we would typically use a downstream Luxembourg LLC or securitization vehicle as a corporate vehicle holding intermediate assets. The aim of the new UK government proposals is to make it easier to use a UK QAHC instead. This could be very appealing to UK based investment managers as it will be easier to demonstrate existing UK substance (due to presence of staff, office etc) and should thus avoid having to build such a substance in Luxembourg. It will also mean that all QAHC meetings could be held in the UK rather than Luxembourg, which could make life easier for some of the UK executives who would like to sit on the company’s board. Additionally, it would avoid having to apply for a conventional passport or other conventional relief to avoid withholding in the UK on interest payments on the underlying UK portfolio debts held by the company.
It is clear that investment managers will not use the new regime unless it is both straightforward and competitive with existing jurisdictions like Luxembourg. So how close are the current QAHC proposals to the establishment of such a regime? It’s fair to say that what we have as a bill is encouraging – however amendments are needed and a number of key areas still need to be addressed or clarified.
How do I qualify as a QAHC?
A condition of ownership must be met to qualify as a QAHC. The details of the test are complex in some ways, but appear to be feasible for most types of alternative credit funds that directly have a QAHC. Essentially, 70 percent of investors in QAHC (not the fund itself) must be “good” investors, and this category will include funds held in various ways that are managed by regulated managers. This category will also include institutional investors such as pension funds, sovereign entities and long-term life insurance companies if these investors directly hold interests in QAHC. A fund held in a diversified manner for these purposes will include non-closed companies (ignoring for these purposes the circumstances where it is closed solely due to the ownership of certain types of institutional investors). It will also include funds that meet the true diversity of ownership requirements.
It is also necessary that the QAHC meet an activity test which is currently unsatisfactory wording (in that it appears to require the allocation of investment risk and also excludes trading activities). It is essential that the practical meaning of these terms be clarified so that there is no risk that the normal activities of credit funds will be excluded due to possible concerns as to what constitutes an adequate allocation of risk (and whether an active management policy or an origination activity can be considered as a commercial activity). However, a more in-depth dialogue is underway with HMRC and we are optimistic that there may be more clarity around this definition.
It is proposed that there is a minimum capital requirement for entry into the QAHC Scheme of £ 50million or £ 100million, but this remains to be resolved.
Main benefits / tax requirements
- It is proposed that QAHC be subject to corporation tax only on a small profit margin at the transfer price. This must be small enough to be competitive with other jurisdictions. We await further information on this key point.
- In order to ensure that corporate tax obligations are minimized in key QAHC anti-avoidance legislation, it will need to be “deactivated”. We understand this will include aspects of anti-hybrid rules, late-payment interest rules, corporate interest restriction rules, and rules that treat profit-related interest payments as a distribution. A bill is expected.
- Key confirmation was given in the second response document that an exemption from UK withholding tax will be introduced for payments made to interest holders in the QAHC (with respect to payments related to such interest). However, there will be no general exemption from UK withholding tax on payments made by a QAHC. For example, ordinary QAHC lenders should seek further exemptions from potential UK withholding tax on interest payments made to them.
- Confirmation was given in the second response document that there would be a mechanism to pass on the underlying gains made by QAHC to investors. As a result, a repatriation of these products to a holder of an interest in QAHC could allow that investor / interest holder to obtain a treatment for capital gains. Unfortunately, this does not appear to extend to the gains on distressed debt. It may be that such gains can still be returned to these investors through a repurchase of financing instruments, but this would seem to require very specific wording of these instruments as well as a taxable profit margin to be retained by the QAHC. in respect of these earnings. .
- Although of lesser importance for debt funds, confirmation was given in the second response document that a capital gains exemption will also be introduced for QAHCs.
- It was also announced that a stamp duty exemption would be introduced on transactions in debt securities that might otherwise not benefit from the existing exemptions for debt securities, for example where debt is convertible or interest depends on benefits. This could apply to redemptions or transfers of such interest. However, no exemption would be provided for transactions in the share capital of QAHC.
- No further update was given regarding possible changes to the VAT treatment of investment management fees. This needs to be the subject of a separate workflow and, although this is an important issue to be addressed, it is of greater importance when it comes to the investment management fees for the fund itself. – even (in the event that the fund was also located in the United Kingdom).
- It will be necessary to choose to enter the regime, and special rules will apply to entering and leaving the regime. In the event that the QAHC undertakes non-qualifying activities, these activities will be separated from the qualifying activities and will not benefit from the special tax benefits of a QAHC.
- HMRC recognizes that the situation of UK residents, but non-domiciled investors, should be taken into account, as a direct investment in a UK entity may be unattractive.
HMRC and HMT have already started a new round of virtual meetings with interested parties regarding the bill and outstanding tax issues. It is very evident that a lot of effort is being put into carrying out broad consultations in order to make the new QAHC regime a success.