QAHCs, US tax-exempt investors and hybrid payer mismatches

05 May 2023

US tax exempt investors in funds can give rise to a hybrid payer mismatch for UK qualifying asset holding companies (QAHCs), despite deriving no tax benefit from this. This makes it doubly important to confirm the application of the 10% and/or QII exceptions within the rules.

We recently led a PETF session focusing on the practical impact of anti-hybrid and CIR rules for private fund structures.

One of the areas covered was the impact of the UK anti-hybrid rules on the tax deductibility of financing instruments issued by a QAHC owned by a fund. The tax deductibility of this financing is, of course, critical to the ability of the QAHC to operate effectively.

In this post, we explore, in more detail, a peculiarity within the UK anti-hybrid rules caused by US tax-exempt investors in a fund.  


In many fund structures, a QAHC will elect to be disregarded for US tax purposes and so will be a hybrid entity (as it is a corporate for UK tax purposes).

As we explained in the session, the QAHC’s disregarded status may give rise to a “hybrid payer mismatch” to the extent of US investors in the fund. This is because the (UK tax deductible) interest payments made by the QAHC to the fund are not included by the investors, due to the QAHC being disregarded in the US. The resulting “mismatch” is counteracted through denial of tax deductions to the QAHC (subject to available exceptions).

Where a fund has US taxable investors, although a hybrid payer mismatch may arise that is attributable to their participation, it is likely that no counteraction will be made on the assumption that these investors will include, for US tax purposes, income arising to the QAHC from its investments (so-called “dual inclusion income”).

The technical outcome where a fund has US tax exempt investors is, however, different.

Where the US investor is tax-exempt, the QAHC’s hybridity arguably has no bearing on whether there is a mismatch – because payments by a regarded QAHC would not be included due to the investor’s tax-exempt status. However, in determining whether a mismatch is a result of hybridity, the rules require you to assume that the relevant investor is taxable. If the investor was taxable, the non-inclusion would likely result from the QAHC’s hybridity.

Because the investor is tax-exempt, there is then difficulty in concluding that dual inclusion income arises to it, because the assumption that the investor is taxable is not expressly carried across to the dual inclusion income exception. In the absence of any exception, there would therefore be a counteraction to the extent of the investor’s participation in the fund.

Managers would be forgiven for finding this outcome strange - that a US tax-exempt investor (who derives no tax benefit from the mismatch) can give rise to a counteraction in circumstances where a US taxable investor does not. However, we understand that HMRC believe this reading of the rules is correct.


We are therefore left with a situation where, if a QAHC is disregarded and there are US tax-exempt investors in the fund that owns the QAHC, the QAHC could be denied a UK tax deduction on its financing to the extent of those investors.

The first point to bear in mind is that the UK anti-hybrid rules now provide for an exception under which a mismatch is ignored if it is attributable to an investor that (broadly) holds less than 10% of commitments to a fund partnership. If a US tax-exempt investor falls below this threshold, there should not be any issue.

Further, a mismatch is also ignored if it is attributable to a “qualifying institutional investor” (QII). A QII is an investor that falls into any of a list of prescribed categories – including, for example, overseas pension schemes. Practically, we would expect many US tax-exempt funds to be overseas pension schemes and so constitute QIIs. However, the “overseas pension scheme” definition is technical and, in our experience, requires some detailed analysis to be satisfied that the conditions are met.

It may also be open to fund managers to adopt a purposive interpretation of the rules – for instance, to the effect that the assumption that an investor is taxable should be carried across to the dual inclusion income exception. However, we understand that HMRC do not see any justification for such an interpretation (although whether they would litigate such a matter over this point is a different question).

Practical impact

In the majority of cases, we would expect either the 10% exception or the QII exception to be available to prevent US tax exempt investors causing a counteraction of deductions under the hybrid payer rules.

However, given our understanding of how HMRC will apply the rules in this situation, in the absence of these exceptions, it is doubly important that:

  • managers ensure that the relative percentage commitments of investors in a fund partnership are monitored, to determine whether the 10% exception is available; and
  • managers obtain sufficient information from investors to determine whether the QII exemption can be relied on. We sometimes see managers ask for confirmation or representation from investors in their subscription documentation as to whether they are QIIs.