With the regulation of investment funds and their managers at the forefront of reviews by regulatory authorities in major economies, fund managers must consider the optimal approach not only for the domicile of funds but also the domicile of the managers of such funds.
This is a summary of the reasons why investment managers are likely to consider moving to an appropriately regulated offshore jurisdiction.
In this economic climate, fund managers need to deal with many issues unrelated to performance or investor relations.
In addition to adverse political commentary, managers face a potentially harsher taxation and regulatory environment.
One such challenge is posed by consultations over tax arrangements, including the UK Investment Manager Exemption (IME) as published by HM Revenue & Customs in the Statement of Practice SP1/01 in 2001 and revised in July 2007.
The IME has been subject to a further consultation in March 2009, as well as changes to the UK tax treatment of
carried interest payable to investment managers on the performance of private equity funds arising out of the withdrawal or restriction of taper relief, which should also be considered in the context of an increase in personal tax rates up to 45% in Britain.
A much greater threat to US investment managers is posed by the Stop Tax Haven Abuse Act. If the Levin Bill were to become law, then an offshore investment fund managed by an American investment manager would become subject to US corporate income tax. To attract foreign and American tax exempt investors, a US-based manager may need to relocate or set up an affiliate outside of America.
These pressures are forcing managers and sponsors to consider the optimal structure for investment management operations, whether located in an onshore location or in an offshore jurisdiction.
In the leading offshore jurisdictions, a favourable political, regulatory and tax climate combined with stability (reinforced by positive responses from the G20 and Organisation of Economic Cooperation and Development (OECD) statements) have built on the familiar advantages of domiciling fund vehicles in offshore jurisdictions, such as tax neutrality, a stable political environment, a sophisticated legal system and high-quality infrastructure and service provision.
Just as these elements are relevant for the determination of the domicile of the fund, they are important to the location of the fund management, or the sponsor-owned vehicles.
This may lead to a mix of jurisdictions to achieve the best result. For example, a Cayman fund with a Channel Islands-based manager is a common approach for European-based managers. There are a number of key factors behind decisions to locate management operations offshore.
Traditionally, offshore jurisdictions such as Guernsey and Jersey have regulated funds and their service providers on a structure-by-structure approach. Typically, this has led to management vehicles needing to obtain regulation as part of, and at the same time as, the fund set up itself.
Although this approach has been practical for traditional retail fund structures, where an offshore management company has been established as part of the fund itself, in the case where managers have been established to be appointed to funds outside of the jurisdiction, this has meant that there has been a tendency to have to seek regulation for the fund in the manager jurisdiction, even where the fund was already regulated in its home jurisdiction.
Guernsey and Jersey have adopted a similar approach to the British Virgin Islands (BVI) and Cayman and now provide for separate regulation of managers, with a variable scale of regulation depending on the funds being managed.
There has been a continued growth in sophistication of the structures used by promoter groups to achieve the right commercial result. These objectives are well-supported by the legal structures that are available in an offshore context.
l tailored participation arrangements and shareholder agreements to reflect the commercial allocation of returns earned by the promoter group. These may be combined with the use of vehicles such as incorporated cell companies and protected cell firms to achieve an appropriate structuring of returns to different recipients of carry;
l use of trusts including employee benefit trusts or international pension structures to achieve flexibility in remuneration. These common methods of providing employee benefits to staff are often easier to implement in an offshore environment as the complex employment tax legislation of onshore jurisdictions does not always apply;
l use of limited partnerships to achieve greater tax transparency on carry arrangements;
l use of multiple equity/carry structures;
These factors are often structured with a view to enabling an effective realisation of the value of the fund management vehicle at a later date.
In the BVI, Cayman, Guernsey and Jersey, the profits of a locally based company involved in the provision of investment management services to investment funds are not taxed.
Most investment managers wanting to establish an entity offshore will do so as part of an existing business based in an onshore location. Traditionally, this will consist in an offshore management firm entering into investment management obligations with the offshore fund and sub-advisory agreements with the (locally regulated) onshore adviser. It is unlikely that there would be any physical relocation of the fund manager itself in establishing an offshore manager.
However, local political, regulatory and tax authorities are trying to encourage firms to set up a real presence in offshore jurisdictions to diversify the local economy and encourage high-value, low-impact businesses such as fund management.
As a result, there is an increasing trend for fund management businesses to establish a presence and for individuals to become resident to establish the primary location of the business in attractive offshore centres in the Channel Islands and the Caribbean.