Final offshore fund regulations released on Friday confirm that where certain conditions are satisfied, a disposal by a private equity fund of an SPV holding an unlisted trading company or group should not give rise to an offshore income gain. This is significant because it means that any gain made on such a disposal will be subject to capital gains tax and not income tax in the hands of UK resident individual investors in tax transparent funds. Thus allowing those individuals access to the more advantageous capital gains tax regime.
This is a positive development and welcomed by the private equity and funds sectors.
As discussed in our bulletin earlier this year, the draft regulations to amend the newly revised UK offshore funds tax regime included a key exception welcomed by the private equity industry.
The draft exception confirmed that a disposal by a private equity fund of an SPV holding an unlisted trading company or group would not give rise to an offshore income gain under the offshore fund rules. Although welcome, it was clear that the exception as initially drafted was overly restrictive and would not apply to all private equity scenarios.
Following a period of consultation, the exception - designed for private equity - in the final regulations has been amended to address concerns raised.
Absent the exception (the "Unlisted Trading Company Exception"), such a disposal could potentially trigger an offshore income gain under the revised regime introduced from 1st December 2009 (making any gain subject to income tax and not capital gains tax). This is a concern for UK individual investors in tax transparent funds (such as private equity LPs) including individual holders of carried interests. For UK tax purposes, such investors are treated as holding interests in the offshore SPVs established by the private equity fund and most such SPVs would be within the scope of the offshore fund rules. This is problematic where a disposal of the underlying investment is made by the SPV and then the SPV distributes the sale proceeds to the fund for distribution to investors.
The new exception from an offshore income gain arising under the offshore fund rules will apply to a disposal of an interest in a non-UK company that would otherwise fall within the offshore fund rules (the SPV) provided that :
- the sole or main purpose of the SPV is to invest in "qualifying companies"; and
- the SPV meets the "investment condition" from the date the SPV was acquired until 12 months before it is disposed of.
"Qualifying companies" are unlisted trading companies, or holding companies of trading groups. The main concern with the exception as originally drafted was the requirement for the SPV to hold 90% of its assets in the form of unlisted trading companies right up to the date of disposal of the SPV. As amended however, the SPV could realise some or all of its holdings and hold the proceeds for up to 12 months, pending distribution to the private equity fund.
The revised exception also relaxes the "investment condition":
At least 90% of the SPV's assets (by value) must be:
- direct or indirect holdings in unlisted trading companies, or holding companies of trading groups;
- listed shares or securities that the SPV intends to dispose of as soon as reasonably practicable and which were either (i) unlisted shares when acquired, or (ii) acquired by the SPV in exchange for unlisted shares or securities; or
- listed shares or securities in trading companies if it is reasonable to believe they would cease to be listed within 12 months (or, if no longer reasonable to assume they would cease to be listed, which the SPV intends to dispose of as soon as practicable).
Further, all holdings of cash are disregarded for the purposes of the 90% test.
Finally, the revised exception is available if the SPV holds only an interest in another SPV that would itself otherwise fall within the offshore fund rules, provided the investment condition is met in respect of that second SPV.
The amendments to the exception are welcome and demonstrate again that the Government has listened to the private equity industry's responses to the consultation. Enabling SPVs that invest mainly in unlisted trading companies to hold significant levels of cash (whether or not pending distribution) and still benefit from the exception shows an awareness of the commercial reality of private equity structures. The relaxation of the strict requirement to hold 90% of assets in the form of unlisted shares and securities is also to be welcomed.
A link to the final regulations can be found here (the relevant provision is Regulation 19).