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Definition
of Fund Investment |
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Fund
investment is suitable for an investor who wants
to be able to choose to invest in a particular
classification of assets (eg London shares, US
property, Russian energy companies, or rock singers'
earnings streams), without having to study the
characteristics of the individual assets. Private
bankers, trust managers or other advisers often
direct some or all of their clients' assets towards
fund investments.
Fund investment spans the gamut of riskiness
(and reward) from ultra-safe, low-yielding bond
funds at one extreme to highly-leveraged derivative
hedge funds at the other. As with other types
of investment, governments in high-tax countries
have constructed a regulatory framework which
reduces both risk and reward, so that investors
in search of high returns are more or less obliged
to look offshore.
If direct equity investment is the fastest-growing
investment sector, then fund investment must take
the palm for diversity. Funds began as a safe
and somewhat tax-privileged way of encouraging
ordinary citizens into stock-market participation,
the idea being to encourage saving while at the
same time deepening the liquidity of stock markets.
But unit trusts (UK) and mutual funds (USA) began
an evolution which soon took them into uncharted
waters, and the more generic term investment funds
includes both the highly-regulated kind of fund
typified by the EU's UCITS legislation, and the
sharp-toothed international tigers so hated by
regulators and control-freak national leaders.
UCITS (= Undertakings for Collective Investment
in Transferable Securities) is a harmonised EU
regime which allows a fund to be marketed into
all EU countries if it conforms with the requirements
of the EU UCITS Directive. Increasingly, public
investment funds in the EU attempt to fall under
the UCITS legislation, for obvious reasons. A
number of offshore jurisdictions within or associated
with the EU have created legislation which accommodates
UCITS-conforming funds. These include Luxembourg,
Jersey and Guernsey.
While it is true that onshore investment funds
cover a wide range of investment targets, the
UCITS legislation allows only for listed securities
to be purchased, and in Europe at any rate national
markets are too small in most cases for adequate
distribution of more specialised funds, which
are in any case hampered by national regulatory
carapaces.
In
November 2006, the European Commission published
a white paper which proposed targeted changes
to the 'UCITS Directive', which, it argued "does
not adequately reflect the challenges facing the
industry today and can give rise to unnecessarily
high compliance costs and missed investment opportunities".
The
proposed changes had the aim of: simplifying the
notification procedure; creating a framework for
the cross-border merger of funds; creating a framework
for asset pooling; enabling fund managers to manage
funds domiciled in other Member States; improving
the quality and relevance of the key disclosure
documents to the end investor; and strengthening
supervisory cooperation to monitor and reduce
risk of cross-border investor abuse. The white
paper also proposed a review of options for establishing
a European 'private placement regime', allowing
financial institutions to offer investment opportunities
to qualified investors across the EU.
Then
in March 2007, the EC published a consultation
on the proposed changes to the UCITs directive,
with the
aim of finalising its formal
proposal by the end of that year.
Internal
Market and Services Commissioner Charlie McCreevy
announced at the time that:
"The
UCITS Directive has served the European fund industry
well. It has been the springboard for global leadership.
But the industry is faced with massive structural
challenges – fragmentation, complex distribution
channels, competition from new investment products.
The current Directive provides no answer to these
challenges."
"That
is why I have pushed hard to strengthen the Single
Market framework for funds. The November White
Paper agreed the steps that were most urgently
needed. This consultation marks the beginning
of the delivery phase. I invite stakeholders to
comment critically on the usefulness, coherence
and cost-effectiveness of our preliminary ideas.
This will ensure that the Commission's subsequent
proposal will really deliver better outcomes for
European investors and market participants."
In
early 2009, after a four-year trudge through the
EU's legislative mechanism, the UCITS4 rules seemed
to be on the verge of acceptance by the Council.
The most important aspect of the new package,
which has survived the political process more
or less intact, is the Management Company Passport,
which will allow cross-border marketing of UCITS-based
funds and should transform the European funds
landscape.
In
the meantime, however, there has been a drift
both for listed and unlisted funds towards offshore,
and also in the case of the US, towards the limited
partnership model, in which a group of investors
can obtain the investment power that comes from
volume while retaining individual tax treatment.
Some offshore (and onshore) jurisdictions distinguish
between large and small groups of investors, providing
a much more relaxed regime for funds with fewer
than 50 investors (partners).
As with equity investment, the first decision
any fund investor ought to make is where to base
his investments. Probably, few investors actively
consider this question until it's already too
late, and the tax damage has been done. That's
understandable if investment begins with a few
thousand dollars or equivalent, almost as a hobby,
and gradually builds up. The investment range
we are dealing with here is bigger (from $100,000
to $5m) and forethought is essential if more than
$100,000 is to be put into funds.
The introduction to this section contained some
general comments on the choice of onshore v. offshore;
the decision where to base fund investment does
not necessarily have to follow the general decision,
and the different tax profile of fund investment
may require that it doesn't. Thus, low-yielding
capital roll-up funds held for the long-term are
a capital gains tax problem, not an income problem,
whereas income funds are the reverse.
There is a vast range of individual situations,
and this section will concentrate on finding and
buying investments, rather than on location. See
the investorsoffshore.com
DIY investment selector for investment guidance
based on specific residential and investor profiles.
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Types of Investment Fund:(1) Private Funds
Most fund investors will want to choose public
funds (see below) because of the liquidity and
flexibility they offer, but some people with a
longer-term horizon and somewhat greater assets
may prefer a private fund.
In essence, a private fund, which is usually
a 'closed-end' fund (ie it runs for a pre-determined
number of years and is then terminated), is set
up among a group of up to 50 people, each contributing
a significant amount of money (it wouldn't normally
be less than $1m each) and invests into a particular
class of assets. The advantages are that professional
managers can use their specialised knowledge of
the selected asset class to obtain higher returns
than can be expected from public funds, which
are often listed, usually open-ended, and almost
always constrained by regulation, even in offshore
jurisdictions, which normally apply some prudential
rules to listed funds, even if these are weaker
than those applied in high-tax countries.
Many offshore jurisdictions provide the necessary
legal infrastructure for private, closed-end funds
to operate, usually via limited partnerships or
limited liability companies. Both of these structures
permit tax transparency in key investor bases
such as the US. The offshore company, or partnership,
is of course lowly-taxed in the first place, and
its individual members or partners can receive
their profits without the interposition of corporate
taxation.
The regulatory regime for closed-end private
funds is usually much more relaxed than that for
public funds, on the grounds that the investors
concerned, being richer, need less protection,
and are perhaps wiser into the bargain.
Further information about the regulation and
taxation of private offshore funds is available
in www.lowtax.net,
in Offshore
Business Review, and in various sections of
individual jurisdictions (Forms of Company, Offshore
Business Sectors, Offshore Legal and Tax Regimes,
and Law of Offshore).
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Types of Investment Fund:(2) Public Funds
Most investors will not want to take on the long-term
commitment implicit in private fund investment,
and will instead prefer the liquidity and transparency
of public funds. Whether or not a public fund
is listed (and most are) the regulatory regime
of any jurisdiction that accommodates public funds
requires frequent and public valuation (nav's),
and an open-ended structure in all but rare cases.
Unlike equities, which have predominantly maintained
their listings on stock exchanges in high-tax
countries (because of the liquidity), public mutual
funds are often based in offshore jurisdictions,
even though their investment targets are not.
Offshore-based funds are therefore a good surrogate
for end-investments in most investment classes,
because most offshore jurisdictions give funds
a pass-through in tax terms, and can often use
double tax treaties to reduce effective tax rates
to low levels - something that would not be available
to a private investor unless he resided in the
offshore jurisdiction concerned, and in many cases
not even then - or at any rate, only with a great
deal of hassle.
Further information about the regulation and
taxation of public offshore funds is available
in www.lowtax.net,
in Offshore
Business Review, and in various sections of
individual jurisdictions (Forms of Company, Offshore
Business Sectors, Offshore Legal and Tax Regimes,
and Law of Offshore).
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How
To Make Offshore Fund Investments
Just because mutual funds, public ones at any
rate, are to some extent sanitised investments,
there are plenty of hurdles in the way of marketing
offshore funds into high-tax areas. For an offshore
fund to be marketed in high-tax countries, it
usually has to conform with local prudential rules
(eg the UCITS directive in the EU, and any subsequent
legislation) and in practice this means that it
cannot offer very interesting returns.
As with private banking, it is not that it is
illegal for a citizen of a high-tax country to
buy 'unrecognised' offshore fund units - it is
illegal for the fund to advertise in the high-tax
area, and it is illegal for the citizen to hold
fund assets without declaring them and paying
tax on the gains from them. If a resident of a
high-tax area unilaterally contacts an offshore
fund, nothing nowadays prevents a transaction
from taking place quite legally (decades ago,
exchange control regulations would have prevented
it).
Residents of high-tax areas who plan to remain
there, and to pay their taxes, may still find
it beneficial to invest in offshore funds because
the funds operate in a less taxed environment
than onshore funds, and will grow quicker; but
most investors in offshore funds will be trying
to optimise taxation directly.
>As
explained in Who Can
Benefit From Offshore Investment, in order
to optimise taxation, it is necessary either to
have residence in a low-tax area, or, for a high-tax
resident, to have an offshore structure that distances
income and capital gains from the investor's domestic
tax regime. Either way, the ownership of fund
assets is going to be offshore, and the main question
is, where to base it?
The choice of an offshore jurisdiction is in
itself a difficult, and to some extent a circular
task. You will not find it easy to distinguish
between the merits of different offshore jurisdictions,
or the facilities they offer, until you have got
to know them quite well. This is the point at
which you might think that an onshore adviser
in your own home country can help you - and it
may be so, but remember that only a very skilled,
knowledgeable and above all, objective, adviser
is going to be useful. Such a person is hard to
find.
www.lowtax.net
is designed to help people who do not have access
to the perfect adviser we just described. www.lowtax.net
is not an investment adviser, and is no substitute
for professional advice, which is an absolute
necessity for anyone planning a move offshore.
But the www.lowtax.net
site does contain a wealth of information about
35 offshore jurisdictions, which is designed to
help you to make a preliminary choice of one or
a few offshore jurisdictions suited to your circumstances,
which you can then explore in depth.
The choice of an offshore jurisdiction as a base
needs to be guided mostly by your own particular
circumstances, but if investments are to be made
into funds (or companies) listed offshore, or
if an offshore brokerage is to be used, then these
aspects need to be borne in mind when making a
choice.
Purely as a factual guide, here is a list (in
alphabetical order!) of those offshore jurisdictions
with developed mutual fund regimes; in most cases,
this also means that they have stock exchanges
(an SE in parentheses) and, you may want to assume,
a fairly high level of sophistication in terms
of investor protection:
Bahamas
(SE)
Bermuda (SE)
British Virgin Islands
Cayman Islands (SE)
Cyprus (SE)
Guernsey (SE)
Hong Kong (SE)
Ireland (SE)
Luxembourg (SE)
Malta (SE)
Mauritius (SE)
Netherlands Antilles
Seychelles
Switzerland (SE)
Turks & Caicos Islands
>www.lowtax.net
has information on the stock exchanges and the
regulatory regime for each of the above jurisdictions.
Our section Gateways To Offshore
Information Providers will lead you to further
sources of such information.
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