Hedge fund structure: offshore-onshore
- John Deane
- Updated: Wed, 26th Oct 2016
Traditionally, hedge funds locate offshore due to tax breaks. Recently managers are moving funds to “onshore” jurisdictions, e.g. Ireland and Luxembourg. Our ability to identify an appropriate structure, and utilise available tax breaks sets us apart.
Our hedge fund structure service includes:
Hedge fund concept
The fund’s aims dictate the structure. All funds aim to deliver a return. However, the following issues help identify an appropriate structure:
- Investors’ capital/income needs;
- Assets under management;
- Open or closed fund, i.e. can investors redeem;
- Hurdles managers expect to meet;
- Investor’s location;
- Investor’s tax needs.
Typical hedge fund models
Typically a hedge fund is:
- Resident offshore, e.g. Cayman Islands;
- A limited liability company that issues shares to investors;
- Managed by a UK entity, usually an LLP; and
- Signs performance and management agreements with the LLP.
Structures for US investors
For US resident investors, a “master feeder” structure is common, tested and proven. Here the offshore company has two “in streams”.
- First “in stream”: Investors invest in an offshore company, which attracts non-US and US tax-exempt investors;
- Second “in stream” : Investors invest in a US LLC or LP, which attracts US taxable investors.
The risk facing the typical offshore structure is the UK management company unwittingly brings the fund into the UK for taxation purposes. Clearly this deters investors, since the fund pays UK tax. HMRC adopts a “permanent establishment” test.
To avoid the fund becoming UK domiciled for tax, an offshore management company manages the fund. All management decisions are made offshore.
The management company signs an advisor’s agreement with a UK LLP. The fund can issue equity-based interests to the UK LLP.
We are part of an international referral network, and frequently work with offshore lawyers. Our offshore lawyers have detailed knowledge and expertise of their jurisdiction. Our relationships reduce your fees compared to traditional fund lawyers with offshore offices.
Offshore fund: tax treatment
“Offshore” funds, for taxation purposes, enjoy tax-free profits. Investors gain an “absolute return” compared to traditional UK investments. However, the UK LLP is tax transparent, so each member pays tax on their income share.
UK-based investors are usually taxed at the dividend rate. The recent budget announced a £5k dividend credit. We work with out network of international lawyers to cater for investor’s tax needs in other jurisdictions.
Offshore hedge fund documentation
Fully implementing your chosen structure requires a host of documents. We provide the whole service to incorporate and run a hedge fund from the UK. A typical offshore structure requires:
- Management agreement: between the fund and UK LLP, or
- the offshore manager if the UK LLP risks bringing the fund into the UK for tax purposes;
- Equity interest agreement: between the fund and the UK LLP, and
- The UK LLP has a performance related interest in the fund’s assets under management;
- Advisor’s agreement: between the offshore management company and the UK LLP, and
- This agreement includes the traditional 2 – 3% fees;
- LLP agreement: – between the LLP’s individual members;
- Tax clearances: if the fund is a reporting fund so UK investors gain preferential tax rates on a capital sale.
Alternatives to the offshore structure
Ireland and Luxembourg are challenging the traditional offshore model. Both countries have their own rules, but both offer funds preferential tax treatment.
We navigate EU regulations and directives to deliver the documentation that properly constitutes “onshore” hedge funds. Our prospectus’ comply with the EU’s strict marketing rules.
Hedge fund structures: track record
Recent instructions include:
- Cayman Islands offshore fund incorporation, including
- Service level management agreements,
- Advisor’s agreements, between
- The fund, the offshore manager, and UK advisor;
- Equity interest agreement between UK advisor and British Virgin Island fund. We redrafted the agreement to ensure it:
- Aligned with the UK advisor’s internal bonus provisions.
- UK LLP disguised remuneration for performance fees: the UK LLP received advisor’s and performance fees, due to interests in multiple offshore funds;
- Service level agreement with UK advisor for British Virgin Island management company: We ensure compliance and reduce risks, by regularly reviewing provisions on a fixed retainer.
Hedge funds often adopt the offshore structure. However, if there is a specific strategy, or a small number of investors, we often propose alternative, superior structures.
Nevertheless, we know the offshore structure works. Our experience is significant.