Hannah Terhune Articles

Why Start an Offshore Hedge Fund? The number of offshore hedge funds continues to increase in numbers. The term offshore means not in your home country and the term does not refer to any one country in particular. Hedge funds are set up offshore usually for tax or regulatory reasons. Hedge fund managers should consider setting up an offshore hedge fund if they expect to have investors from other countries or if their home country’s laws are not geared toward the hedge fund industry. With a handful of exceptions, most countries have high territorial and jurisdictional taxes. Why would someone not from your home country want exposure to your home country’s tax laws? Offshore hedge funds are generally organized as corporations for marketing, tax, and legal reasons especially when the investors live in high tax jurisdictions.

We Offer an International Bias Our law firm is based in the United States but we have solid ties to law offices and hedge fund lawyers around the globe. We can set up offshore funds anywhere in the world. At times on this web site we note items of interest for U.S. fund organizers. However, most of what we suggest to U.S. fund promoters applies equally to non U.S. fund promoters.

UBTI Blocker Funds For example, U.S. based hedge fund managers expecting U.S. tax-exempt investors to invest in the fund (i.e. retirement accounts and pension funds) should set up an offshore hedge fund (i.e. a UBTI blocker entity) when margin trading is required to execute the hedge fund’s trading program. The reason for this is the need for such tax-exempt investors to avoid unrelated business taxable income (UBTI) tax exposure. Under U.S. income tax laws, a tax-exempt organization (such as an ERISA plan, a foundation, or an endowment) engaging in an investment strategy that involves borrowing money is liable for a tax on unrelated business taxable income (UBTI), notwithstanding its tax-exempt status. The UBTI tax can be avoided by the tax-exempt entity by investing in non-U.S. corporate structures (i.e. offshore hedge funds). The end-result is an offshore UBTI blocker fund.

While the foregoing is a unique concern of U.S. tax law, similar laws in other countries encourage non U.S. based fund promoters to set up offshore funds. We are aware of how home country tax and regulatory issues can drive the decision to form an offshore hedge fund. We also know that awareness of the need for a UBTI blocker fund is helpful to the non U.S. fund manager seeking to open an offshore fund that would be of interest to U.S. investors. That said, we are based in the United States but have a truly global focus.

Good Sense Supports Offshore Hedge Funds Hedge funds are set up as offshore and/or onshore funds to allow for different groups of investors. Hedge fund managers who have significant potential investors from different countries create offshore funds to make it easier to blend their customer base. Many hedge fund managers use offshore hedge funds to provide financial privacy to investors.

Hedge Fund Countries If the major consideration for establishing an offshore hedge fund is efficiency, the arrangement of the hedge fund structure and the choice of offshore country are important. The majority of the hedge funds are established in low or zero tax jurisdictions (i.e. tax havens). This means that there is no corporate level tax on hedge fund profits. Since most hedge funds are set up as corporations (except in the United States where they are set up as either limited partnerships or as limited liability companies) that do not declare and pay dividends to their shareholders, investors (i.e. shareholders) do not have dividend income to declare for tax purposes in their home country. Therefore no taxes are due for either the hedge fund or its investors.

For a new hedge fund manager who is a small operator the best location to launch an offshore hedge fund is the United States. the British Virgin Islands. the Bahamas. or the Cayman Islands. These countries have favorable hedge fund and tax laws that allow hedge funds to start out as unregulated funds (private two share class companies) with the option to upgrade to a licensed (i.e. fully regulated, full-fledged) hedge fund. It is not necessary to set up a licensed, fully-regulated hedge fund. In fact, for smaller startups, it is far better and more practical to set up a hedge fund structure that allows it to operate as an unregulated hedge fund. Setting up a licensed, fully-regulated hedge fund takes more time and money.

For example, in the British Virgin Islands, you can set up a Closed-Ended Fund, a Private Fund or a Professional Fund. In the Bahamas. you can set up a SMART Fund. In the Cayman Islands. you can set up an Closely Held Exempt Hedge Fund or a Regulated Hedge Fund.

This may come as a surprise to many but the United States does not tax hedge fund entities and is an excellent offshore jurisdiction for those not based in the United States. In the United States. you can set up a Private Hedge Fund or an Publicly Offered Hedge Fund under Regulation D. Contact Us for Assistance