UK Asset Holding Companies: What Does the Future Hold?
March 01, 2021
Cadwalader, Wickersham & Taft LLP
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The UK Government’s public consultation on Asset Holding Companies (AHCs) just closed from December 15, 2020 to February 23, 2021. The UK Government’s objective in the consultation was to improve the government’s understanding of AHCs, the Funds, structures in which they are used and the commercial drivers of their location, as well as introducing legislative changes that bring clear benefits by the Facilitate the flow of capital, income and profits between investors and the underlying investments in the AHCs. The first consultation document was published in March 2020 under the UK Treasury’s 2020 budget (First Consultation). The second consultation document (Second Consultation) was published in December 2020 and launched the recently completed public consultation phase.
In conclusion, the second consultation has focused on trying to remove a number of key barriers to developing a workable and attractive regime for AHCs in the UK. We have summarized some of the key aspects of the second consultation below and considered some of the challenges facing government in each of these areas presented.
- Breadth of consultation: One of the challenges for the UK government in the second consultation was the broad scope of the AHC consultation itself. Both the first and second consultations covered a wide variety of structures and arrangements including alternative loan funds, securitisations, private equity and real estate investments. Creating a viable AHC regime that is equally effective across such a variety of asset classes has proven difficult.
- International comparisons: The UK government has a clear goal in trying to improve the UK’s status as a global wealth management and financing center. This goal would be well served by the creation of a popular, functional, and effective AHC regime. British companies within an AHC regime could benefit from practical tax advantages, for example the ease of being able to demonstrate international tax base given the existing British business activities of many financial market participants. There would be benefits to the UK Treasury if a popular AHC regime could be created, including direct tax benefits from pro-rata taxation and related employment taxation. However, these practical benefits can only be achieved if some salient challenges can be removed. One of the most important is how well the British AHC regime would hold up against international competitors, particularly in Ireland and Luxembourg. Is it enough for a UK AHC regime to offer comparable advantages over other UK domestic structures? Or should the AHC regime offer at least the same advantages as other international regimes or should it even improve itself optimally compared to its international competitors?
- Withholding Tax: The UK has a 20% withholding tax on interest payments on unlisted loan securities. In comparison, Luxembourg does not levy withholding tax on interest payments on loans. Any interest payment on unlisted debt from a UK AHC should therefore have a way of eliminating such withholding tax costs, especially since some investments in an AHC are likely to be made by widespread collective investment vehicles where the eligibility of contracts may be difficult to track. If the British AHC regime does not provide for withholding tax exemption for interest payments, the international comparison with other regimes would be unfavorable and obvious.
- Capital Gains and UK Participation Exemption: Capital gains on holdings within a UK AHC or AHC group will be a major topic of discussion in the second consultation. While the risk of UK corporate tax liability on sales of assets for an alternative loan fund is less likely, the opportunity for capital gains is highly relevant to real estate investments by an AHC. Finding a single solution for all asset classes that would not give AHC investors a disproportionate advantage over other UK corporate investors was one of the challenges in the second consultation.
- Real Estate: Investors generally have to pay taxes on rental income and capital gains on UK real estate, even if those investors are based outside the UK. This tax treatment of non-UK investors in UK commercial real estate was only tightened in UK tax law in 2019. One of the questions in the second consultation is whether this basis for UK property taxation under the AHC regime should be maintained and how that tax regime could effectively co-exist with property holdings outside the UK under the AHC regime. A broader question to be addressed in the UK Government’s ongoing and parallel review of the UK funds industry is how a real estate AHC might work alongside a UK REIT. While REITs and AHCs can support different investor bases, the government needs to ensure that these two regimes are mutually supportive, not biased.
- Value Added Tax: For many years, industry associations and tax advisors have been campaigning to ease UK rules on VAT on administration fees. The government announced in the second consultation that the VAT collection on management fees charged to a UK AHC will be taken into account in the broader review of UK funds. This is a visible distinction between Ireland and Luxembourg, which currently exempt certain administration fees from VAT. The change in VAT rules for management fees is likely to be one of the reasons for how the AHC consultation is seen by investors and industry participants. In a post-Brexit context where international tax competition is viewed as suboptimal, such a change in VAT could be politically difficult to achieve.
- Investor Taxation: The questions of how investors in a UK AHC are taxed and at what level (AHC or investor level) are some of the most complicated elements of the second consultation. For example, the government has proposed to introduce a regime-specific exemption for investment capital gains at the AHC level. However, in the second consultation, it was suggested that this exemption be pinned to a traceability proposal so that amounts returned to AHC investors that are attributable to investment capital gains are treated as capital gains in the hands of investors. Side questions arise as to whether such a traceability method would be simple, predictable, practical and, perhaps most importantly, attractive compared to comparable international regimes. The problem for the UK government is to create a regime that maintains the appeal of a clear exemption but still maintains fairness to the broadest group of UK taxpayers who use other UK investment structures and stand in comparison to international competitors.
- Legislative Timeline: Finally, one might wonder if the AHC project timeframe is too ambitious. The public consultation took place from December 15, 2020 to February 23, 2021. The legislation is being envisaged by the UK government in the 2021 Finance Act, a breathtakingly tight date for consultation on this complexity and far-reaching implications.
If all of the tax and policy challenges identified in the second consultations can be resolved within the UK government, the chances are that the UK AHC regime, when compared to other domestic investment structures, offers an effective and affordable UK tax regime, possibly convincing when alongside international competitors. The fascination of watching the progress of the second consultation is that the UK’s position in a post-Brexit and post-COVID Europe could provide the incentive for ambitious reforms. It is just as uncertain, however, to what extent other, more well-known burdens from austerity measures and fears of an erosion of the tax base could speak against radical changes.
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