The purpose of these asset holding companies is not limited to tax although tax efficiency including treaty access is often key. The government wants to understand the purposes of the asset holding companies and also understand what potential benefits the introduction of tax efficient UK AHs could have both in terms of the tax take and the creation of new jobs in the UK. There is also a defensive aspect of introducing new rules in this area which is to prevent the potential risk of the migration of the UK management activities to the location of the non-UK fund jurisdiction which tends to increase the commercial efficiency and underpin the substance of fund structures.
It is acknowledged that the UK already has a tax efficient regime in place for UK holding companies given the wide treaty network access, and exemptions for capital gains and dividends together with no withholding tax on dividend payments. However, these benefits would need to be enhanced before UK AHs could compete with other EU jurisdictions in the intermediate company asset holding space for alternative funds. Ireland already has an existing attractive intermediate asset holding company regime (the section 110 company) and Luxembourg also has a favorable securitization vehicle regime together with a competitive transfer pricing regime where asset holding companies are in the form of ordinary Sarls. In contrast, the current UK regime presents difficulties with respect to potential restrictions of tax deductions for interest payments and other tax rules resulting from an overzealous implementation of the anti-hybrid rules which is currently making the possible use of such a vehicle tax inefficient.
More specifically, in the context of credit funds, difficulties can arise in avoiding material tax leakage when structuring back-to-back lending arrangements, which are common in order to repatriate proceeds from the underlying portfolio back to the fund. The UK does have a bespoke tax regime for securitization transactions involving a capital market arrangement but these rules are often restrictive or uncertain as to whether they apply to a given situation. In the context of real estate funds it would also be important to consider further relaxations to the capital gains exemption (the substantial shareholder exemption) in order to ensure that the exemption could operate in relation to the sale of a subsidiary company notwithstanding that the investor base is not primarily represented by qualifying institutional investors. Additional changes would also be helpful for private equity structures and funds that operate carried interest arrangements to ensure that returns from UK AHs can be treated as capital in nature for tax purposes (such as the distribution rules on a repurchase of shares).
It is also noted (although the manner of expression appears to convey some degree of skepticism) that the fact that the UK imposes a 20% withholding tax on most interest payments to non-UK lenders (unlike a number of other EU jurisdictions) and despite the existence of exemptions (such as the quoted Eurobond exemption) also presents a potential barrier to UK AHs. The reality is that in the context of a European lending fund, the fact that the UK has such withholding tax is often a key consideration in the structuring of the asset holding company arrangements which are invariably outside the UK.
The dreaded UK anti-hybrid rules are also noted as a potential general barrier to UK AHs and it is certainly true that the approach taken by the UK with its current legislation is much tougher than appears to be the case with other EU jurisdictions although a review of these rules generally was also announced in Budget 2020.
The government is considering changes either in the form of amendments to the existing general rules for UK companies or otherwise asks whether it might be preferable to introduce a new specific favorable tax regime for UK AHs.
Ultimately, while introducing new tax changes to the existing rules for UK companies or alternatively a new tax regime for a UK AH would be a major step in the right direction, there also would need to be significant tax and regulatory changes to the existing UK alternative fund regime before the UK can seriously compete with Luxembourg and Ireland in relation to the establishment of international alternative fund structures. At present, the VAT rules are also a major barrier as the government recognizes. At present, irrecoverable VAT costs can be an absolute cost in establishing UK funds, either because the fund itself will incur irrecoverable VAT on investment management fees or where the supply is exempt from VAT, a loss of VAT recovery for a UK investment manager as compared to providing the same services to a non-UK fund. The VAT exemption is interpreted in a wider manner in Ireland and Luxembourg and furthermore the provision of investment management services by a UK investment manager to an Irish- or Luxembourg-based fund will often enable attributable VAT on costs incurred by the UK investment manager to be recovered.
This consultation represents an important opportunity for the industry to push for the introduction of new UK tax rules to enable the UK to compete with existing EU jurisdictions in relation to the establishment of intermediate asset holding structures for international funds. The consultation will run until May 20, 2020.
