The UK Government’s public consultation on Asset Holding companies (AHCs) has just finished, having run from December 15, 2020 to February 23, 2021. The objectives of the UK Government in the consultation have been to improve the Government’s understanding of AHCs, the fund structures in which they are used, and the commercial drivers of their location, as well as to introduce legislative changes which bring clear benefits by facilitating the flows of capital, income and gains between investors and the underlying investments in the AHCs. The first consultation document was published in March 2020 as part of the UK Treasury’s 2020 Budget (First Consultation). The second consultation document (Second Consultation) was published in December 2020, and initiated the public consultation period which has just recently closed. 

In summary, the Second Consultation has focused on attempting to reduce a number of key roadblocks in designing a workable and attractive regime for UK AHCs. We have summarized some of the key aspects of the Second Consultation below, and have considered some of the challenges for the Government in each of those featured areas.

• Breadth of the Consultation: One of the challenges for the UK Government in the Second Consultation has been the wide-ranging remit of the AHC consultation itself. Both the First Consultation and Second Consultation have covered a wide variety of structures and arrangements, including alternative credit funds, securitizations, private equity and real estate investments. Creating a viable AHC regime which is equally effective across such a diversity of asset classes has proved challenging. 
• International Comparisons: The UK Government has a clear objective in attempting to enhance the UK’s status as a global asset management and financing center. That objective would be well-served by the creation of a popular, workable and effective AHC regime. Practical tax benefits might well flow to UK companies within an AHC regime, such as the ease of being able to demonstrate international tax “substance” given the existing UK operations of many financial market participants. Advantages would follow for the UK Treasury if a popular AHC regime can be created, including direct fiscal benefits from proportionate taxation and the taxation of linked employment. However, those practical benefits can only be achieved if some prominent challenges can be removed. Foremost among these is how well the UK AHC regime would fare alongside international competitor regimes, particularly those in Ireland and Luxembourg. Is it sufficient for a UK AHC regime to provide comparable benefits compared to other UK domestic structures? Or would the AHC regime need to convey at least the same benefits as other international regimes or even, optimally, improve on its international competitors?
• Withholding Tax: The UK imposes a 20% withholding tax on interest payments regarding unlisted loan securities. By comparison, Luxembourg does not impose withholding tax on interest payments on loans. Any interest payment on unlisted debt from a UK AHC would therefore need to have some way of eliminating such withholding costs, particularly as some investment in an AHC is likely to be made from widely-held collective investment vehicles where treaty eligibility may be difficult to trace. Unless a withholding tax exemption on interest payments is present in the UK’s AHC regime, the international comparison with other regimes would be unfavorable and obvious.
• Capital Gains and the UK’s Participation Exemption: Capital gains arising on asset holdings within a UK AHC, or AHC group, are a significant topic of discussion in the Second Consultation. While the risk of UK corporation tax liability on asset disposals is less likely to be a problem for an alternative credit fund, the possibility of capital gains is highly relevant for real estate investments made by an AHC. Finding a single solution encompassing all asset classes, which does not provide a disproportionate advantage to AHC investors when compared to other UK corporate investors, has been one of the challenges in the Second Consultation.
• Real Estate: Investors generally have to pay tax on rental income and capital gains on UK-situated real estate, even if those investors are resident outside the UK. This tax treatment for non-UK investors in UK commercial real estate was reinforced in UK tax law as recently as 2019. One of the questions in the Second Consultation is whether this basis of taxing UK real estate should be preserved in the AHC regime, and how that taxing regime could sit effectively alongside non-UK real estate holdings within the AHC regime. A wider question to be addressed in the UK Government’s ongoing, and parallel, review of the UK funds industry is how a real estate-holding AHC might operate alongside a UK REIT. While REITs and AHCs may support different investor bases, ensuring that these two regimes operate in a mutually supportive and non-distortive manner is something the Government will need to accomplish.
• VAT: For many years, industry bodies and tax practitioners have lobbied for a relaxation of the UK’s rules regarding VAT on management charges. Achieving VAT recovery for management fees charged to a UK AHC will, the Government has announced in the Second Consultation, be considered in the UK’s wider funds review. This is a visible distinction with Ireland and Luxembourg, which currently exempt certain management charges from VAT. Changing the VAT rules for management charges is likely to be one of the bellwethers of how the AHC consultation is viewed by investors and industry participants. In a post-Brexit context, where international tax competition is viewed as being sub-optimal, such a VAT change might be politically challenging to achieve.
• Investor Taxation: The questions concerning how investors in a UK AHC bear taxation, and at what level (at the AHC, or at the investor-level), are some of the most complicated elements of the Second Consultation. For example, the Government has proposed to adopt a regime-specific exemption for investment capital gains at the level of the AHC.  However, the Second Consultation proposed stapling that exemption to a tracing proposal, so that amounts returned to AHC investors that are attributable to investment capital gains are treated as capital gains in the hands of the investors. Subsidiary questions arise regarding whether such a tracing methodology would be simple, predictable, workable and – perhaps most importantly – attractive compared to comparable international regimes. The problem for the UK Government is in creating a regime which maintains the attractiveness of a clear exemption but still maintains fairness to the widest group of UK taxpayers utilizing other UK investment structures and stands comparison against international competitors.  
• Legislative Timetable: Finally, one could be forgiven for wondering if the timescale of the AHC project is overly ambitious. The public consultation has run from December 15, 2020 to February 23, 2021. Legislation is planned by the UK Government in the Finance Bill 2021, a breathtakingly close date for a consultation of this complexity and wide-ranging impact. 

If all the challenges identified in the Second Consultations can be solved at a tax policy and political level within the UK Government, there is a chance that the UK AHC regime may offer an effective and favorable UK tax regime compared to other domestic investment structures, and possibly may be compelling when placed alongside international competitors. The fascination in watching the progress of the Second Consultation is that the UK’s position in a post-Brexit, and post-COVID, Europe might provide the stimulus for ambitious reforms. What is just as uncertain, however, is the extent to which other, more familiar, pressures of fiscal austerity and fears of tax base erosion might militate against radical changes.