IFM40260 - Eligibility criteria: trade versus investment

The activities that a qualifying asset holding company (QAHC) will undertake are likely to be prescribed as part of the investment strategy of the entity or entities investing in the QAHC.

There is no particular provision within FA22/SCH2 that determines whether an activity undertaken by a company amounts to a trade or an investment, and therefore it will depend upon the particular facts.

HMRC guidance on the general meaning of trade can be found at BIM20000+ and these pages should be consulted when considering whether the activity condition at FA22/SCH2/PARA13(1) has been met. General guidance on financial traders can be found at BIM56800.

Additional guidance is available in Statement of Practice 1 (2001). Part II includes commentary on whether certain activities might constitute a trade or an investment.

The following examples may be helpful in further illustrating the application of FA22/SCH2/PARA13 especially in the context of a credit fund. These examples are illustrative and not exhaustive.

Example One

The AHC acquires assets which it intends to hold for the medium to long term. There is not generally a high turnover of assets or number of transactions within the AHC.

This is likely to constitute investment activity, including where the assets acquired by the AHC are debt instruments. It is the intention at the point of acquisition which is important here. If external events (such as changes in the market) mean that assets have to be disposed of sooner than intended, or there are offers for assets that mean the manager of the AHC opportunistically considers such offers and sells some of them, this should not in itself change the analysis as the AHC is actively managing its investments, unless there is a change of intention in relation to the assets in question. The AHC should retain evidence of its initial intention (for example, promotional literature or offering memoranda for investors which set out the AHC’s strategy of investing in assets for the medium to long term) and any changes in that intention. Other suitable evidence could include board minutes or internal correspondence.

It is not possible to be specific about what constitutes “medium to long term”. Regular sales of assets within months or even weeks of their acquisition may indicate that the AHC does not have an intention to hold assets for the medium to long term (although see Example Three below where a bundle of assets is acquired). Conversely, regular retention of assets for several years may be considered as evidence of an intention to hold for the medium to long term.

Example Two

The AHC only acquires assets which it intends to hold in the short term. There will be a high turnover of assets and number of transactions over the life of the AHC.

This is likely to constitute a trade, irrespective of the nature of the assets held and particularly where the AHC has operations otherwise characteristic of trading.

Example Three

The AHC acquires a bundle of assets in order to be able to purchase a particular target asset within that bundle. The other assets do not form part of the overall investment strategy, therefore the AHC plans to dispose of them quickly. The AHC immediately starts to seek, or execute, opportunities to dispose of these assets, and successfully disposes of most or all of them. Some are sold at a profit and some at a loss. As intended, the AHC retains the target asset(s) in line with its medium to long term investment strategy.

This would typically constitute investment activity provided there is evidence of this intention to retain the target asset for medium to long term and that this is borne out by what the AHC actually does. The activity condition would therefore likely be satisfied in the absence of other characteristics of a trade, some of which are described below.

Where the AHC does not specify any particular investment strategy, and is therefore simply guided by making positive returns based on market movements on any basis without reference to investment strategies or holding periods, this might constitute a trade.

If the unwanted assets make up a substantial proportion of the overall asset bundle acquired, there is a greater likelihood that the activity constitutes a trade, particularly if the AHC has dual objectives of unbundling assets to sell some of the constituents at a profit and retaining others which fit its longer-term investment strategy.

AHCs should retain evidence of their strategy, including the nature and holding intention in relation to the various assets acquired. Suitable evidence could include board minutes or internal correspondence as well as promotional literature produced for investors.

Example Four

An AHC undertakes loan origination activities and, in some cases, receives fees as part of its overall return from the loan investment.

It will be a question of fact whether fees received by the AHC form part of the return on its investments or are fees for an action. Such fees could include origination, participation, documentation or consent fees and may form part of the investment return in a similar manner to the receipt of interest income. Where an AHC originates a debt investment rather than acquiring debt on the secondary market this is not, by itself, an indication that the AHC is trading.

If an AHC originates loans and holds (or intends to hold) a significant portion of them for the medium to long term as part its investment strategy, the loan origination activity will likely constitute part of the overall investment activity. If so, income generated by originating and holding the loans, including participation, origination or execution fees, would be investment income.

However, fees for arranging loans for others to hold, such as syndication fees, are likely to be the result of trading activity. Unless this trading activity is ancillary to the investment activity and not carried on to a substantial extent, the AHC is not likely to meet the activity condition. The quantum of syndication fees received compared to the other investment returns of the AHC is likely indicative of both whether the syndication activity is ancillary to this investment business and whether it is carried on to a substantial extent.

Example Five

An AHC has a strategy of investing in distressed debt.

If the AHC intends to hold this debt for medium to long term, then this is likely to constitute an investment activity, even if opportunities are taken to sell down the debt, rather than hold to maturity, or if the AHC participates in debt restructuring or other insolvency activities as a result of investing in the debt.

A greater level of activity by an AHC in relation to such distressed assets, such as leading a restructuring or insolvency process (where the other investors simply participate) might amount to a trade. This will depend on whether the AHC holds a significant position which gives it a better position than other creditors to lead the process. The receipt of fees for carrying out such activity may indicate trading particularly where these fees are not ancillary to the main investment activity.

Constantly renewing the book of distressed assets with a view to short term realisation may amount to a trade. This includes where distressed debt is acquired in anticipation of a restructuring with a view to disposing of the resulting asset immediately after the restructure regardless of its value. Conversely, where the restructuring results in a different asset (for example, equity) or unlocks or preserves value within the debtor’s business, this is likely to constitute investment where the relevant asset is then retained for medium to long term.

However, it will be a question of fact in each case.