The UK Qualifying Asset Holding Company (“QAHC”) Regime

Analysis and comparison with the Luxembourg SOPARFI

Purpose of this position paper

The Qualified Asset Holding Company (“QAHC”) regime is a holding company regime which was introduced in the UK to enhance the competitiveness of the UK towards other jurisdictions (for example, Luxembourg) as a location for asset management and investment funds.

The QAHC regime was introduced by Schedule 2 of the Finance Act 2022 (hereafter referred to as “FA22/SCH2”) and came into force on 1 April 2022.[1]. The QAHC regime is therefore relatively new and there is still some uncertainty about some of the details.

As the UK is one of the most important jurisdictions for investment management, the question arises as to whether the QAHC regime may make it easier for investment funds to establish their holding platform for international investments in the UK rather than in Luxembourg via the traditional “Société de Participations Financières” (“SOPARFI”).

It is sometimes argued that it is easier to organise the substance of an investment vehicle in the UK than in Luxembourg, given that UK investment managers should have a substantial presence in the UK. This idea has been raised in particular in relation to the draft EU Council Directive laying down rules to prevent the misuse of shell entities for tax purpose (the so-called "Unshell Proposal") that has been released on 21 December 2021.

In order to answer the question of whether the QAHC regime is more advantageous than the SOPARFI for the implementation of an investment platform for cross-border investments, it is necessary to analyse the legal and tax characteristics of the QAHC and compare them with those of the SOPARFI. It is also necessary to analyse how the QAHC and the SOPARFI are treated from the perspective of the investment jurisdiction. Finally, it is important to consider substance requirements and the limitations imposed by EU law in an EU context (as applicable in the case of the SOPARFI).

This position paper will shed light on all these aspects and help the reader to gain a clear understanding of the legal and tax features of the QAHC and how these compare to the features of the SOPARFI, as well as to consider Luxembourg's competitiveness.

The purpose of this position paper is to:

· Provide a clear and concise overview of the QHAC regime;

· Make a comparison with the features of the Luxembourg SOPARFI regime; and

· Consider substance requirements.

This is abridged version of the L3A position paper entitled “The UK Qualifying Asset Holding Company (“QAHC”) Regime – Analysis and comparison with the Luxembourg SOPARFI”.

For more information, please refer to the unabridged version that can be found on our website.

[1] Schedule 2 to the Finance Act 2022 (https://www.legislation.gov.uk/ukpga/2022/3/enacted), referred to as “FA22/SCH2”, supplemented by HMRC explanatory notes (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm40000).

Analysis of the QAHC regime

Alternative investments may involve different asset classes such as private equity, private debt, real estate, and infrastructure. Investments are typically made via a Luxembourg fund vehicle and subsidiaries that are resident in Luxembourg and in the investment jurisdiction. Alternatively, foreign funds may establish an investment platform in Luxembourg for investments into Europe.

The QAHC regime is a holding company regime introduced in 2022 in the UK to make the UK more competitive vis-a-vis other jurisdictions (e.g. Luxembourg) as a location for asset management and investment funds.

The QAHC regime may apply to unregulated companies which are resident for tax purposes in the UK (but they cannot be listed companies). However, there are significant differences between the QAHC regime and the SOPARFI.

Unlike a SOPARFI, the QAHC regime is subject to specific conditions, primarily relating to its ownership, operational activities and investment strategy. The most important features of the QAHC regime are analysed below. The analysis of the UK legal framework and the QAHC tax regime is based on publicly available documents.

· Conditions of the QAHC regime

For a company to qualify as a QAHC, it must meet certain criteria relating to its ownership, activities and investment strategy, and it must be resident for tax purposes in the UK [2]

In addition, its securities must not be publicly listed or traded on a recognised stock exchange or market and it must not be a UK REIT or a securitisation company.

The conditions for benefiting from the QAHC regime include two key aspects:

- the type of investors: a QAHC must have at least 70% of its "relevant interests" held by a specific category of investors ("Category A Investors") that are classified as "good investors" under the QAHC regime; and

- the type of investments made: the primary activity of a QAHC must be investment-related activities, subject to specific investment strategy conditions.

· The “at least 70% good investor” requirement

Given the definition of "good investors", "bad investors" (i.e. investors who are not "Category A Investors") include closed-end funds, funds that are not widely held, and family-owned businesses and companies that are not funds. Carried interest holders and, in general, management should also not be considered “Category A Investors”.

The ownership requirement is one of the conditions of the QAHC regime that creates complexity and uncertainty. The calculation of the 70% minimum threshold for "Category A Investors" applies to both direct and indirect interests in the QAHC, taking into account both legal and economic rights.

· Permissible investment activities

The main activity of the QAHC must be the carrying on of an 'investment business' and the other activities may only be carried out on an ancillary basis and not to a substantial extent.[3]

However, the term 'investment business' remains undefined in FA22/SCH2 and HMRC's explanatory notes indicate that whether a particular activity is an investment or a trade will depend on the specific circumstances, creating considerable uncertainty.

While some illustrative examples are provided in the explanatory notes, the interpretation of what constitutes an ancillary activity and when an activity ceases to be an ancillary activity remains unclear.

· Prohibited investments

The QAHC regime defines certain prohibited investments. Accordingly, the investment strategy of the QAHC must not include:

- the acquisition of equity securities listed or traded on a public market or exchange, except for the purpose of facilitating a change of control of the issuer resulting in the delisting of the securities; or

- other interests that derive their value from such securities, subject to certain exceptions

· Management of the QAHC

The QAHC regime is subject to ongoing compliance with strict eligibility conditions. To maintain its status under this regime, the company must continuously monitor both its ownership structure and its investments.

This monitoring is not just a recommendation but a requirement under FA22/SCH2. Under §12 of FA22/SCH2, a QAHC must take reasonable steps to ensure that the ownership conditions are consistently met.

· Ring-fencing rules

The QAHC tax regime applies only to assets within the ring-fence. Assets outside the ring-fence are subject to the standard UK tax regime, just like any other company.[4]

The assets falling within the ring-fence encompass:

- overseas land;

- qualifying shares (any shares other than shares in UK property rich companies[5] (i.e. shares whose value is at least 75% derived from UK land)[6]);

- any creditor relationship;

- derivatives on land, qualifying shares and debt; and

- derivative contracts to the extent that the QAHC is party to them for the purpose of carrying on its investment business in relation to the above[7].

Given the above definition, assets outside of the “ring-fence” include, for example:

- investment in non-qualifying shares;

- carrying on a UK property business;

- carrying on an overseas property business which is not exempt from corporation tax by virtue of the QAHC rules; or

- carrying on any trading activity.

· Registration process

The registration process for the QAHC regime involves certain formalities, including the submission of an entry notification to HMRC.

· Tax regime

Dividends and capital gains derived from qualifying participations may benefit from a tax exemption. Likewise, gains realised from foreign real estate assets and overseas property business income may be exempt if certain conditions are met.

While interest income should be taxable at the standard UK corporate income tax rate, in case of financing activities, the UK QAHC would not be expected to realise more than an arm’s length finance margin.

Interest and dividend payments made by the QAHC should not be subject to withholding tax in the UK.

· Substance requirements

The QAHC is subject to significant substance requirements. To qualify for the QAHC regime, a UK company must be resident in the UK for tax purposes. This determination is based on where strategic decisions are made at the highest level, as opposed to day-to-day operations.

Given the specific legal monitoring and reporting obligations of the QAHC, it can be expected that the fulfilment of these functions, including human resources, will require a higher level of substance than a SOPARFI, which is not subject to such obligations.

Whilst UK based investment managers typically have significant substance in the UK, the substance (including employment) must be transferred to the QAHC to be considered as substance of the latter. Therefore, it may not necessarily be easier for UK investment managers to organise substance in the UK (rather than in Luxembourg).

QAHCs are not protected by EU law when investing in EU Member States. As a result, the tax authorities of EU member states may require more substance than they could in an EU context (e.g. in relation to a Luxembourg SOPARFI).

· Considerations regarding the Luxembourg SOPARFI

The SOPARFI is a tried and tested regime that provides for a beneficial participation exemption regime that generally results in a tax exemption of dividend income and capital gains. When investing into foreign real estate, Luxembourg companies can rely on tax treaties concluded by Luxembourg which frequently provide for the application of the exemption method for the avoidance of double taxation (regardless of the tax treatment in the situs state of the real property).

Interest payments made by Luxembourg companies are not subject to Luxembourg withholding tax (as long as these payments adhere to the arm’s length standard). Dividend payments are generally subject to Luxembourg withholding tax at a rate of 15% with exemptions (or reduced withholding tax rates) being available under Luxembourg tax law and bilateral tax treaties.

The SOPARFI regime applies as from the creation of the company and is not conditional to the shareholders of or the type of investments made by the company. The Luxembourg SOPARFI regime does further not involve any ring-fencing rules. Consequently, the SOPARFI requires less monitoring and involves less administrative burden and costs than the QAHC.

Luxembourg SOPARFIs must have an appropriate substance for the activities they carry out. This includes, in particular, good corporate governance, which concerns the composition of the board of directors, the organisation of board meetings in Luxembourg, the involvement of qualified Luxembourg directors in the decision-making process and the proper documentation thereof (i.e. in board minutes, email correspondence, internal memos, etc.). It is important that all major decisions concerning the management of the company are taken in Luxembourg.

This should in most cases be sufficient to keep Luxembourg companies outside the scope of foreign anti-abuse legislation or anti-abuse provisions in bilateral tax treaties. In this respect, Luxembourg companies can rely on the restrictive jurisprudence of the Court of Justice of the European Union ("CJEU") regarding anti-abuse rules in the EU context.

[2] But does not necessarily need to be incorporated in the UK.

[3] §13 of FA22/SCH2. A recharge activity should hence not per se be prohibited for a QAHC as long as it remains an ancillary activity.

[4] https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm40350

[5] Defined by reference to the UK non-resident capital gains rules.

[6] “Shares” is broadly defined and includes interests of members in companies without share capital, certain rights of unit holders in unit trusts, certain units in transparent funds and derivatives (https://www.gov.uk/hmrc-internal-manuals/investment-funds/ifm40930).

[7] On the contrary, are outside the “ring-fenced business”: investment in non-qualifying shares, carrying on a UK property business, carrying on an overseas property business which is not exempt from corporation tax by virtue of the QAHC rules or carrying on any trading activity.