HMRC recently updated the guidelines for the UK’s new qualifying asset holding company (QAHC) tax regime introduced from 1 April 2022. The new guidance clarifies HMRC’s approach to whether business lending vehicles used by credit funds should be treated as carrying on an investment business or a commercial activity as part of the obligation for a QAHC to carry out investment activity, any trading activity being purely incidental to it, which is examined below.
The QAHC regime was introduced with a view to increasing the competitiveness of the UK as an asset management jurisdiction. Generally speaking, the regime aims to provide a tax-neutral holding (or, in the context of credit funds, loan) company structure where the relevant conditions are met. The main benefits of the plan include:
- Exemption from withholding tax for all interest payments made by a QAHC;
- Deduction of interest generated by participating (or “results-dependent”) loans and certain other “special securities” for which interest payments would otherwise be treated as non-deductible distributions;
- Exemption from tax on capital gains realized on the disposal of shares in UK or non-UK companies (provided these companies are not rich in UK property) and non-UK property;
- Exemption from stamp duty and SDRT on the repurchase of own shares or loan capital;
- Payments made by a QAHC on redemption, redemption or purchase of its own shares are not treated as distributions (except for management at the holding company level); and
- Remittance basis of taxation may be available to fund managers on income and gains from foreign assets held through a QAHC (subject to special remittance basis rules applicable to deferred interest ).
The scheme is accessible to UK tax resident companies of which at least 70% of the owners are so-called “category A” investors. Category A investors include certain qualifying funds, the QAHCs themselves, certain specific types of investors (including those with sovereign immunity, pension plans, charities and authorized persons engaged in long-term insurance), public authorities and certain non-UK companies wholly owned by one or more Class A investors who are not QAHCs.
At a high level, the other plan availability conditions are:
- the principal activity of the company consists in carrying on an investment activity and any other activity is incidental to this activity and is not substantial;
- its investment strategy does not involve the acquisition of listed securities; and
- none of its shares are listed or traded on a recognized stock exchange.
To learn more about the details of the QAHC scheme and eligibility requirements, please read our submission to the PIF 2021 Annual Review and Outlook here.
Thus, where a company is engaged in commercial activity, the regime will only be available if the commercial activity is merely incidental to the main investment activity and is not substantial. Following the introduction of the scheme, there was some uncertainty among asset managers as to whether credit funds that engage in loan origination (or other debt-related activities) could be considered to be in the business of trading and/or whether the fees they received in connection with their principal lending activities (such as arrangement fees, facility fees and syndication fees) could be considered as trading income. If the basic activity was considered commercial or if the fees were treated as commercial income that was more than insignificant in the context of the activities of the company as a whole, the scheme would not be available. Depending on the characterization of standard loan origination activities, this could mean that a significant number of loan funds could not use the scheme, which would have had the effect of undermining the policy objectives of the scheme in the context of these funds.
After discussion with industry stakeholders, HMRC has updated the relevant section of its QAHC guidelines published in the context of credit funds. In summary, the guidance now confirms that loan origination is not in itself indicative of a transaction and that where loans are originated with the intention of being held for the medium or long term under the QAHC’s investment strategy, it is likely that this will be part of its (main) investment activity. With respect to fees, the guidelines indicate that fees which are only part of the loans at origin, such as arrangement fees, are likely to be investment income and simply part of this main investment activity if the loan itself is an investment activity. However, fees charged for arranging loans for others, such as syndication fees, may well be business income from a business activity separate from any investment business the company may also be engaged in. Guidance indicates that the best test for determining whether syndication fees are incidental and not material may be the value of those fees relative to the investment returns received by the company.
Similarly, with respect to the acquisition of distressed debt, the updated guidance provides that where such assets are acquired with the intention of being held for the medium to long term, this is likely to constitute a investment, even when the assets are disposed of before termination of the loan on an opportunistic basis. Conversely, higher levels of activity in relation to distressed assets, such as conducting a restructuring or insolvency process (and generating costs from these activities), may indicate a transaction. However, this is a question of fact to be assessed on a case-by-case basis.
These updated guidelines provide a welcome clarification of HMRC’s interpretation of how QAHC legislation should apply to lending/debt acquisition companies set up by credit funds, which should provide reassurance to investment managers. credit professionals who are considering using QAHCs within their fund structures. The guidance also outlines HMRC’s view of whether particular lending-related activities constitute trading or investing activities in general and as such may be more broadly relevant to loan funds. who do not consider the use of QAHC within their structures.