A new UK tax regime is around the corner.
The message is clear – it is about trying to catch up with Luxembourg as the incumbent preferred EU hub to establish, amongst others, private credit holding structures. The UK’s economic and finance ministry (HM Treasury) is contemplating an enhancement of the tax regime applicable to UK-based asset holding companies (AHCs) to make the island a competitive location for the holding of alternative assets, including for private loans, in a post-Brexit world.
An analysis by Remy Vincent, EY Luxembourg Partner, International Tax.
How would a Luxembourg investment company generally be structured in a credit fund?
A credit fund, typically in Luxembourg, would generally invest in loans/debt securities using an intermediate Luxembourg vehicle for the purpose of the actual investment as well as allowing, inter alia, for segregation, possible leverage strategies and access to the Luxembourg double-tax treaty network. The Luxembourg legal system is widely recognized as being very flexible and giving certainty with clear framework in certain key aspects when establishing credit platforms e.g., collateral law on the creation and enforcement of financial collateral arrangement or the securitization law for compartmentalization and bankruptcy remoteness.
The Luxembourg investment vehicle can be financed with an instrument whose return is linked to the performance of the underlying debt portfolio. In line with applicable transfer pricing rules, the Luxembourg investment vehicle is taxable on an arm’s length basis. Under Luxembourg law, no withholding tax is levied on the return paid to the investor in the fund. It should be noted that there are no eligibility criteria (with respect to investors or else) for this tax treatment to apply.
How do UK AHCs compare and what are the suggested changes?
Currently, if a UK AHC was set-up underneath a credit fund, the use of a financing instrument whose return is linked to the income of an asset would lead to inefficiencies, as such payment would generally be treated as a distribution of profits for which deductions are disallowed. Unlike in Luxembourg, interest payments are also subject to a withholding tax of 20%, which creates an additional tax burden and thus a decrease of the net return for the investor.
HM Treasury is now considering allowing deductions for results-dependent instruments and is also exploring to what extent an AHC should be exempt to withhold tax on payments of interest.
What are the next steps in the UK and the take-away from Luxembourg?
Detailed consultation by HM Treasury is still on-going with potential legislation expected to be issued in the last quarter of 2021. At this stage, it appears that the AHC regime will presumably have to fulfill certain criteria to be eligible. Envisaged criteria (the extent of which would have to be confirmed as legislation go out) seem to relate to the investors (to ensure that the regime does not serve the interests of single / limited number of investors, including thus suitable ways to identify the investors in an AHC), to the asset manager (who would be required to be authorized or registered and subject to supervision, and be independent of the investors) and to the character and activities of an AHC, i.e., the AHC regime should only apply to entities that serve to facilitate flows of capital, income and gains between investors and investment assets. Furthermore, it seems that it is not envisaged to broaden the UK securitization regime, which has a narrower scope than the Luxembourg framework.
This announced new UK tax regime should certainly be monitored and may well increase the attractiveness of the UK. All in all, it remains that when credit managers establish their fund and investment companies, Luxembourg remains at the top of list given that it offers: solutions to all credit strategies, protection and familiarity for investors, flexibility of structuring and legal certainty. The recent trend of alignment of the fund raising, the EU passporting and the asset holding in the Grand-Duchy should remain the norm for credit managers.