The qualifying factor
Nothing to do with ducks, despite the acronym, the Qualifying Asset Holding Company (QAHC) regime has proven popular among UK asset managers, having been implemented roughly 180 times since its inception in April 2022.
The UK financial market has been navigating a tightrope of regulatory changes, attempting to reinvent itself as a competitive fund domicile ever since that fateful day on 31 January 2020 when the UK formally exited the EU.
Three years on from Brexit, various product launches and key strategies – including the Edinburgh reforms, the Greening Finance Group and the LTAF – have attempted to maintain the UK’s attractiveness.
The QAHC is yet another of these innovations, but to what extent has it affected the UK’s alternative funds landscape? What has it solved so far and what is there still to be done to continue to enhance the UK’s presence?
Fitting the bill
QAHCs offer enticing tax benefits because they provide broad exemptions from capital gains on most shares, whereas in Luxembourg the same benefits are subject to other conditions.
Substance-wise, it should be straightforward for UK GPs to reside in the country, while there is uncertainty around ATAD III and the future of substance requirements in Luxembourg.
Further, there is no withholding tax on dividends or interest paid by a QAHC.
However, fund managers need to ensure they meet the eligibility criteria of more than 70% of the fund controlled by Category A investors. In Luxembourg, there is no such requirement.
Luxembourg might also win when it comes to capital returns for UK investors. In the UK, company law might pose a problem, although the QAHC has made it easier than it used to be. Jennifer Wall, private equity tax partner at BDO, explains further: “Master UK holding companies traditionally made it difficult to access capital returns. The QAHC regime is better at removing the need for dividend distributions to access cash.”
Overall, QAHCs offer a good alternative to offshore holding companies for those in scope and those that can meet the substance requirements.
Show and tell
Emily Clark, head of asset management at Travers Smith, shares which firms have seen an uptake in QAHCs: “We've seen asset managers, who haven't made that big investment in Luxembourg yet, think about using them.”
She adds that larger GPs with investments in Luxembourg are also considering QAHCs for specific strategies or new products. Lastly, UK pension funds are also looking into this vehicle.
Clark states: “All groups are attracted by the potential to save costs because they already have people in the UK.”
One firm that has successfully set up six QAHCs is MML – the process in the UK has been positive and straightforward, given that it already had substance in the region.
Karan Darroch, finance director at MML, shares some key reasons why the firm elected to use the QAHC regime: “Timing played a key role in our decision. We happened to be looking at these structures around the time QAHCs were launched by the UK Government. Meanwhile, there was a real threat of running into trouble if you didn’t have enough feet on the ground in Luxembourg. Since then, that threat has somewhat diminished.
“Notwithstanding that, it has always been expensive and cumbersome to set up holding companies there. The availability of the QAHC regime suited us at the time because the cost of managing and administering these vehicles is significantly cheaper, plus it’s more straightforward than in Luxembourg.”
For many GPs, setting up holding companies in Luxembourg proved difficult because of the arduous banking process, taking months to set up a bank account before being able to physically incorporate an entity.
Moreover, moving away from Luxembourg removes the added element of layering legal counsel, something that is administratively burdensome and costly.
At MML, the decision proved to be low risk, given that the firm was certain of meeting the diversity of ownership requirement and its investors were onboard with the move.
While the overall sentiment is positive (although it is early days), there are still some drawbacks to consider associated with remitting proceeds. Darroch explains: “You need to make sure you engage with legal counsel to have the paperwork in place, and to have distributable reserves to comply with UK company law. That being said, that’s really an administrative process and I don’t see any real concerns, particularly for the type of assets we invest in.”
Setting up UK holding companies is certainly an attractive move, but the UK’s political instability may pose a further threat, with the potential to counteract developments like the QAHC regime. Put simply, a tax-efficient wrapper is futile if tax is potentially added elsewhere should the definition of carried interest change.
A lawyer specialising in EMEA asset management discusses the implications of a change in carried interest: “If the UK were to be a first mover on any change in tax treatment, that could put the country in a difficult position, particularly with the number of deal individuals here who are originally from other parts of the world. The possibility of being subject to an increasingly negative tax treatment could be difficult to accept.”
Another concern left unsolved by the QAHC regime is the ability to perform cross-border transactions in a post-Brexit world. While it makes it easier and more cost effective for GPs who already have substance in the UK to set up holding companies in the same location, most will still domicile their funds elsewhere. That’s not about to go away.
Benjamin Lamping, founder and CEO of investment solutions provider Reframe Capital, warns of the detrimental impact Brexit has had: “I think that Brexit has been hugely detrimental to the UK funds industry because UK regulated managers are no longer permitted to avail of the pan-European marketing passport and offer their products to investors across the EU. There remain further uncertainties over the ability of UK firms to continue managing European funds on a cross-border basis. So, I see a real challenge for the government to build a greater rapport with the EU and ensure ongoing access to the European marketplace.”
Darroch elaborates: “It’s still easier to raise outside of the UK because that’s what our investors know, particularly as they are predominantly European LPs, which would make it harder to market a UK-based fund and raise capital.”
It seems the QAHC regime is a positive step forward in terms of boosting the UK’s competitiveness in the alternative funds industry, particularly for UK fund managers, but problems with cross-border transactions and political instability remain unsolved.