Offshore funds – variously known as collective investment schemes or mutual funds – are vehicles, registered or domiciled in IFCs, that are designed to allow investment in a fund without being exposed to the burdens of onshore tax or regulation. They offer eligible investors significant benefits in terms of tax neutrality, speed, flexibility and pragmatic regulation in comparison to most onshore jurisdictions.
IFCs are generally considered investor-friendly, well regulated and financially secure. Many IFCs offer a zero-tax regime for investment funds that are domiciled there, enabling the fund to reinvest that part of its investment portfolio’s gains that would otherwise have been lost to tax. Most onshore funds operate at a tax disadvantage to non-resident investors because dividends are often subject to high rates of withholding and taxes – commonly as high as 30%.
An offshore fund can be managed similarly to an onshore fund and when income is repatriated to a high tax jurisdiction it is usually taxed at normal rates as foreign sourced or arising income.
In addition, the regulatory regime in IFCs is deliberately light, with emphasis placed on the importance of balancing effective regulation for the benefit of the protection of investors on the one hand, with the establishment of a regime in which the conduct of investment business is fast and simple.
Typically, IFCs take a two-tier approach, making a distinction between funds that are offered generally to members of the public – which require a high degree of regulation – and private or professional funds where investors can be assumed to be sophisticated or expert investors because of the nature of the offering.
Generally there is a high minimum initial investment, often US$100,000 or a requirement that investors establish that they are “professional investors”. Alternatively a fund will be designed for a small and select group of investors and the constitutional documents will restrict the number of investors, often to a maximum of 50.
Although most IFCs permit funds to obtain licences to operate as public funds, the onerous regulatory requirements associated with such licences usually mean that only a small minority of offshore funds is available for subscription by the general public.
Offshore structures are typically used to pool investments for private equity funds, venture capital funds, distressed opportunities funds, real estate funds, mezzanine funds, funds of funds and hedge funds.
The relative absence of regulation relating to leveraging and investment strategies in IFCs encourages higher risk funds, such as hedge funds, to form themselves in those jurisdictions. The vast majority of the world’s hedge funds are formed in IFCs, particularly the Cayman Islands, British Virgin Islands, Luxembourg or the Bahamas.