Overview

• The UK government has today released its response to its consultation on the tax treatment of asset holding companies (AHCs) used in alternative fund structures. Despite its slightly dull sounding title, today's response is one of the most significant (and positive) tax developments for the UK asset management industry in recent years.
• The general thrust is that the UK has listened to industry and is now exploring introducing a bespoke tax regime for AHCs.
• If introduced, this has the potential to make the UK a competitive location for AHCs which, in turn, may drive investment to the UK and encourage on-shoring of many types of structure.
• The government believes that there is a clear policy justification and a strong economic and fiscal case for reform in this area.

What was the consultation about?

• The consultation focused on "alternative funds", which are essentially private funds targeting institutional investors, rather than retail investors such as individuals. These funds have experienced exceptional grown in recent years, with truly eye-watering amounts of cash invested into private equity, real estate, private debt and infrastructure funds.
• The growth in alternative funds has historically benefited the UK, as its asset management sector is easily the largest in Europe and the UK remains home to many of the management teams that drive the investment decisions.
• Most funds of this nature are established using some kind of tax-transparent partnership vehicle (often a limited partnership). While limited partnerships are generally well suited for "pooling" investors' cash, fund investments are typically held through one or more holding companies that sit below the fund vehicle. It is generally preferable for these corporate entities to contract with third parties (for example, to buy and sell investments) rather than the fund vehicle, as a corporate has separate legal personality and limited liability.
• Despite the pre-eminent role played by UK-based asset managers, relatively few funds use UK-incorporated holding companies. Most European funds use holding companies established in Luxembourg, Ireland or the Netherlands partly because the tax rules in those jurisdictions are perceived to be more straightforward and "user friendly", even though the underlying management teams are often located in the UK.
• However, various tax and non-tax developments now make it desirable for a fund's investments to be held in a jurisdiction where the manager has a physical presence. It is clear from today's response paper that the government intends to encourage the use of UK asset holding companies to protect existing UK jobs and to make the UK a more competitive jurisdiction for the asset management sector overall.

A "bespoke" regime for fund asset holding companies

• The headline policy proposal set out in the government's response paper is a proposal to introduce a bespoke regime for AHCs that is simple, and easy to apply in practice.
• The paper explicitly recognises that the "cardinal principle" of fund structuring is "to leave the investor in no worse position, from the perspective of tax paid on investment income and gains, than if they had invested directly in the underlying assets", and indicates that the government will tailor the regime to achieve this outcome.
• Inparticular, the new regime will be built around the following three core design features:
  • robust eligibility criteria to limit access to the intended users;
  • an approach to taxation of the AHC itself that will ensure any tax it pays is commensurate with its role; and
  • rules for UK investors to ensure that they are taxed on income and gains received from an AHC broadly as if they had invested in underlying assets directly.
• The government will undertake a second round of consultation on the specific eligibility criteria to access the regime. A number of possible options are canvassed in the response paper, and it seems likely these criteria will require the involvement of an authorised asset manager (of some description), and the pooling of funds from third party institutional investors.
• The specific benefits of the regime will also be addressed in this next round of consultation. However, it seems very likely that many disadvantageous UK tax rules that have deterred funds from using UK holding companies to date may be disapplied for AHCs.
• The follow-up consultation will also consider changes to the UK's REIT regime with a view to ensuring it is similarly competitive with equivalent regimes in other jurisdictions.

Conclusion

• Any movement in this direction may simplify the position for many structures and give the UK a competitive edge. This would be extremely welcome for UK industry.
• We are working through the detail of the government’s response and will provide some additional information on this in due course, as well as continuing to monitor any developments.
• If you would like to discuss any of these issues, please do feel free to get in touch.