Offshore fund
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An offshore fund is generally a collective investment scheme
domicile Domicile may refer to: * Home, a place where someone lives * Domicile (astrology) In astrology, a planet's domicile (or less commonly house, not to be confused with the astrological house system) is the zodiac sign over which it has rulership ...
d in an
offshore jurisdiction An offshore financial centre (OFC) is defined as a "country or jurisdiction that provides financial services to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy." "Offshore" does not refer ...
. Like the term "
offshore company The term "offshore company" or “offshore corporation” is used in at least two distinct and different ways. An offshore company may be a reference to: * a company, group or sometimes a division thereof, which engages in offshoring business pro ...
", the term is more descriptive than definitive, and both the words 'offshore' and 'fund' may be construed differently. The reference to offshore, in the classic case, usually means a traditional offshore jurisdiction such as the
Cayman Islands The Cayman Islands () is a self-governing British Overseas Territory—the largest by population in the western Caribbean Sea. The territory comprises the three islands of Grand Cayman, Cayman Brac and Little Cayman, which are located to the ...
,
Jersey Jersey ( , ; nrf, Jèrri, label=Jèrriais ), officially the Bailiwick of Jersey (french: Bailliage de Jersey, links=no; Jèrriais: ), is an island country and self-governing Crown Dependencies, Crown Dependency near the coast of north-west F ...
or the
British Virgin Islands ) , anthem = "God Save the King" , song_type = Territorial song , song = "Oh, Beautiful Virgin Islands" , image_map = File:British Virgin Islands on the globe (Americas centered).svg , map_caption = , mapsize = 290px , image_map2 = Brit ...
. However, the term is also frequently used to include other corporate domiciles popular for cross border investment structuring, such as
Delaware Delaware ( ) is a state in the Mid-Atlantic region of the United States, bordering Maryland to its south and west; Pennsylvania to its north; and New Jersey and the Atlantic Ocean to its east. The state takes its name from the adjacent Del ...
and
Luxembourg Luxembourg ( ; lb, Lëtzebuerg ; french: link=no, Luxembourg; german: link=no, Luxemburg), officially the Grand Duchy of Luxembourg, ; french: link=no, Grand-Duché de Luxembourg ; german: link=no, Großherzogtum Luxemburg is a small lan ...
. In the widest sense, offshore is sometimes used to include any type of cross border collective investment scheme, and popular fund domiciles such as
Ireland Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic Ocean, in Northwestern Europe, north-western Europe. It is separated from Great Britain to its east by the North Channel (Grea ...
may be included within the definition of offshore, notwithstanding their substantial size as a country. Similarly, although the reference to fund can be taken to include any sort of collective investment, within offshore jurisdictions themselves, the term offshore fund is often limited to purely open-ended investment funds (i.e. a fund where the investor can redeem his investment during the life of the fund) where the investment is by way of equity (rather than by debt). This is often because closed-ended investment funds (where the investor cannot redeem out), and funds where the investment is structured by way of debt, are not normally subject to the usual regulatory requirements for investments funds, and so are not treated as funds in the stricter sense of that word. Although the term is often used as a simply descriptive one, many onshore countries have specific definitions in their legislation or their tax codes for when an investment is treated as an offshore fund. For example, in the United Kingdom see the Offshore Funds (Tax) Regulations 2009, and in the United States see section 871 of the Internal Revenue Code of 1986.


Structuring

Most offshore funds are formed as either an
offshore company The term "offshore company" or “offshore corporation” is used in at least two distinct and different ways. An offshore company may be a reference to: * a company, group or sometimes a division thereof, which engages in offshoring business pro ...
, partnership - typically a limited partnership - or (less commonly)
unit trust A unit trust is a form of collective investment constituted under a trust deed. A unit trust pools investors' money into a single fund, which is managed by a fund manager. Unit trusts offer access to a wide range of investments, and depending on ...
in the relevant jurisdiction, and investments will characteristically be by way of equitable interest (i.e. shares, partnership interests or units). In addition to the fund itself, most offshore funds are required by local regulations to have various functionaries most of whom are also required to be licensed under applicable legislation. These include: * an administrator * a
manager Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business. Management includes the activities ...
* a
custodian Custodian may refer to: Occupations * Janitor, a person who cleans and maintains buildings * Goalkeeper, in association football * Fullback, in rugby, also called a sweeper * Legal guardian or conservator, who may be called a custodian in some ...
* a
prime broker Prime brokerage is the generic name for a bundled package of services offered by investment banks, Wealth management, wealth management firms, and Security (finance), securities dealers to hedge funds which need the ability to borrow securities a ...
* (in certain jurisdictions) an authorised representative In certain cases exemptions will be available. For example, feeder funds in a master-feeder structure are often exempted from the requirement to appoint a custodian, and the requirement to maintain a custodian may be waived where the prime broker also fulfils the role of custodian. Most jurisdictions also require that offshore funds submit audited accounts to the regulatory annually. Almost all jurisdictions require directors of offshore funds to satisfy regulatory criteria in relation to fit and proper persons, but some jurisdictions also require directors to be separately licensed.


Global market/world share

Market share in offshore funds is normally measured either by number of funds or assets under management (AUM). However, different sources may vary in relation to market share according to (i) which jurisdictions are considered to be "offshore" and which types of collective investment schemes are included. In relation to hedge funds (the archetypal offshore fund product) Cayman has a dominant market share. Figures for private equity funds, an investment product with similar liquidity constraints, are markedly different, with Delaware enjoying over half the market on either measure.


Regulation


Offshore

Most developed offshore jurisdictions provide a broadly similar regulatory regime in relation to funds formed in their country. Typically, the regulatory regime will take a two tier approach, making a distinction between funds which are offered generally to members of the public (which will require a high degree of regulation because of the nature of potential
investors An investor is a person who allocates financial capital with the expectation of a future return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...
), and non-public funds. Non-public funds are usually either categorised as private funds or professional funds or some equivalent label. Typically, investors in non-public funds can be assumed to be sophisticated because of the nature of the offering – there may, for example, be a high minimum initial investment, say US$100,000, and/or a requirement that investors establish that they are "professional investors" (although some offshore jurisdictions allow investors to self-certify this). Alternatively the fund may be designed for a small and select group of investors and the constitutional documents will limit the number of investors, say to no more than 50. Although most offshore jurisdictions permit funds to obtain licences to operate as public funds, the onerous regulatory requirements associated with such licences usually means that only a small minority of offshore funds are available for subscription by the general public. Most offshore domiciling of funds tends to be regulatory driven rather than tax driven. The relative absence of regulation relating to leveraging and investment strategies in offshore jurisdictions encourages higher risk funds, such as
hedge fund A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...
s, to form themselves in those jurisdictions.


Onshore

Increasingly, economically developed countries are imposing direct regulation on offshore funds who wish to market to investors in those countries. The most recent example of this is the
Alternative Investment Fund Managers Directive Directive 2011/61/EU is a legal act of the European Union on the financial regulation of hedge funds, private equity, real estate funds, and other "Alternative Investment Fund Managers" (AIFMs) in the European Union. The Directive requires all c ...
(AIFMD) which requires funds to comply with extensive rules and regulations in order to be able to market to investors within the European Union.


Taxation


Offshore

Typically the offshore jurisdiction in which a fund is incorporated will not impose any direct taxation on the income of the fund. Nor will it impose any withholding or similar income taxes on distributions by the fund to its investors. However, this does not normally operate to exempt the fund from taxes which may arise as a result of its investment activities in other countries. So, for example, if a fund formed in the Cayman Islands realises a capital gain on trade in New York, it will still normally be liable for U.S. capital gains tax in the usual way. Similarly, if a person domiciled in the United Kingdom invests in a Guernsey fund, they will still be liable to taxation of income and capital gains received under British tax laws (subject to the rules on remittance of foreign earned income), notwithstanding the absence of any taxation imposed in Guernsey.


Onshore

Different onshore countries treat income arising from offshore funds in different ways. US citizens are generally subject to taxation on foreign earned investment income regardless of whether they live in the world and where the income is remitted to. Under British tax rules, the taxability of foreign earned income depends upon the domicile of the tax payer and whether the funds are remitted to the United Kingdom. There is a public perception that offshore investment funds are responsible for tax leakage in relation to cross border investment, and various laws have been passed by various countries shaped by that belief. Probably the best example of that is the American Foreign Account Tax Compliance Act (FATCA). But earlier examples also included the application of the
European Union withholding tax The European Union withholding tax is the common name for a withholding tax which is deducted from interest earned by European Union residents on their investments made in another member state, by the state in which the investment is held. The Eu ...
to the British Overseas Territories (including popular offshore fund domiciles like the Cayman Islands and the British Virgin Islands). The most recent (and ongoing) example is the Convention on Mutual Administrative Assistance in Tax Matters which almost every major offshore fund domicile has agreed to be bound by.


Criticism

Critics, such as
ATTAC The Association pour la Taxation des Transactions financières et pour l'Action Citoyenne (''Association for the Taxation of financial Transactions and Citizen's Action'', ATTAC) is an activist organisation originally created to promote the e ...
(an NGO), alleged that they are a main player of the
underground economy A black market, underground economy, or shadow economy is a clandestine market or series of transactions that has some aspect of illegality or is characterized by noncompliance with an institutional set of rules. If the rule defines the se ...
, allowing legalized
tax evasion Tax evasion is an illegal attempt to defeat the imposition of taxes by individuals, corporations, trusts, and others. Tax evasion often entails the deliberate misrepresentation of the taxpayer's affairs to the tax authorities to reduce the taxp ...
, in particular through the usage of
shell corporation A shell corporation is a company or corporation that exists only on paper and has no office and no employees, but may have a bank account or may hold passive investments or be the registered owner of assets, such as intellectual property, or s ...
s practicing
transfer pricing In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort ...
.


See also

* Collective investment schemes *
Offshore Financial Centre An offshore financial centre (OFC) is defined as a "country or jurisdiction that provides financial services to nonresidents on a scale that is incommensurate with the size and the financing of its domestic economy." "Offshore" does not refer ...
s * Offshore 2020


References


{{Investment-management Investment funds Offshore finance Legal entities