Asset holding company regime: latest developments
We are anticipating some final legislative changes to the rules in the Finance Bill report stage towards the end of January 2022. Again, these expected changes are set out below.
Changes to draft legislation just before Christmas
Ownership condition and interaction with qualifying fund definition
The main change to the draft legislation was to the definition of a qualifying fund. One of the classes of a qualifying fund (the relaxed non-close test) has been removed. This essentially allowed a closely held fund to qualify under the non-close limb if a sufficient amount of its investor base comprised of Category A investors. Following the change, in order for a fund to qualify on the basis of being non-close, the (largest five investors holding less than 50% of the fund) assessment will need to take account of all investors, including Category A investors.
Instead of the relaxed non-close test, the GDO and non-close routes to qualifying fund status have been supplemented by a new test that allows a CIS or AIF fund to be a qualifying fund if it is at least 70% controlled by Category A investors. Given that carried interest (which will not be held by Category A investors) is included in the assessment, this test will require all or almost all of the investors in the fund to be Category A investors. It will therefore only be used for funds of one (or a few) or where the master fund has qualifying feeder funds (themselves Category A investors) which can then qualify the master fund.
Surprisingly the 70% test looks at votes as well as economics, which is odd given investors get to vote on relatively few matters in a funds context. We have highlighted to HMRC that the voting test may be difficult to apply in practice. This point may be addressed by a change at the report stage or through guidance.
The relaxation from including specific wording in a prospectus in order to satisfy the GDO test has been extended to funds raised up until the commencement of the regime (1 April 2022). This will allow existing funds to satisfy the GDO test where they were widely marketed even though they do not satisfy some of the procedural requirements of the full test.
There remains an issue with the way GDO operates in relation to a master fund where the investors participate via one or more feeder fund. While the offshore fund GDO rules incorporated in the QAHC rules allow a feeder fund with the same manager to be treated as part of the master fund for these purposes, that easement only applies where the feeder fund is an offshore fund, which a partnership feeder fund cannot be. We have pointed this oversight out to HMRC and hope it will be fixed at report stage.
Definition of carried interest arrangements for determining relevant interests in the AHC
There are rules that treat carried interest as a fixed percentage in applying the various percentage ownership tests within the rules. This means that the carried interest is treated as, say, 20% of the interest in the fund for the purposes of the non-close or 70% test, not the percentage from time to time (which could be 100% during the catch up). This easement was previously drafted not to apply where the carried interest was held otherwise than by an individual performing investment management services. It now applies whoever the holder is, provided the carried interest is held “in connection with the provision” of investment management services. This has helped address the position of “house” carry or carry held by an executive in a discretionary trust when calculating the entitlement to profits for the relevant interest test.
On a related note, there is an omission in the current drafting of the close fund test that means this variation (see para 9(5)(b)(iii)) does not apply to corporate funds. This omission means that a widely held corporate fund with carry could be considered close during the catch-up period. Given a corporate fund cannot satisfy the GDO test this will be an important point to address. We anticipate this will be fixed at report stage.
Close fund test and creditors
An amendment has been made to the close fund test which modifies the way in which the interests of creditors are accounted for by ignoring the right a person has as a creditor in respect of normal commercial loans. Although the amendment fixes the issue in relation to the main economic control test within the close company rules, the same exclusion does not exist in the winding-up control test which currently only excludes ordinary bank debt. We are anticipating this will be fixed at report stage.
Further anticipated changes at report stage
Using the close company test to determine whether a fund is close
In determining whether a fund is close or not, the close company test under s450 CTA 2010 is adopted however this presents a number of challenges when applied in practice. These include:
- while the fund cannot be close only because of the GP’s/manager’s voting power (per Sch5AAA TCGA modifications to the close company test), this does not extend to other control that the manager can exercise over the fund (for example through a management agreement);
- the share capital test does not make sense in a partnership fund which does not have share capital;
- in applying the voting test, we presume it is necessary to look at LP voting as anticipated under the 70% test, but this is not clear; and
- it is not completely clear whether the income test should be applied to gross or net income.
We expect these issues to be clarified in changes at report stage.
The Directly and Indirectly rule
There is an incorrect cross-reference in Schedule 2 para 4(3) to sub-para 4(1)(b)(1) the effect of which could be to treat indirect interests as direct interests, thereby causing the Directly and Indirectly rule to apply where it should not. We expect this point to be fixed at report stage.