Waves Of Change Hit Shores Of Offshore 'Tax Havens'

Many fund managers establish investment funds in offshore "tax haven" jurisdictions to satisfy the tax efficiency requirements of their tax-exempt investors (i.e., non-profit entities such as foundations and pension funds). The use of offshore jurisdictions for the purpose of tax avoidance has been a great success for tax-exempt investors, much to the chagrin of the U.S. Congress, which recently estimated that more than $100 billion in tax revenue is lost each year due to investments in offshore funds.

Congress is currently contemplating restricting the ability of U.S. tax-exempt entities to generate tax-free income from investments in offshore funds. Specifically, Congress is scrutinizing the tax-exempt entities' use of offshore "blocker" corporations to avoid paying unrelated business taxable income ("UBTI"). Under current law, certain tax-exempt entities may avoid paying UBTI merely by investing through a company organized in an offshore jurisdiction.

The last time Congress passed significant legislation regarding offshore funds was in 1997, when it repealed the "Ten Commandments." As a result, offshore funds that trade for their own accounts are deemed not to be engaged in a U.S. trade or business even if the fund manager maintains its principal office in the U.S. However, Congress did not take action to restrict the ability of tax-exempt entities to take advantage of offshore jurisdictions, due in large part to the commitment of the U.S. to foster economic development in the Caribbean region. Whether or not the current Congress is fully committed to restricting the use of offshore jurisdictions remains to be seen. For now, it appears that offshore jurisdictions will continue to be attractive to U.S. fund managers and their clients.

Traditionally, offshore jurisdictions have been attractive to fund managers because the offshore jurisdictions typically subject the fund managers and their clients to a reduced regulatory regime and favorable tax treatment. However, based on recent developments, offshore jurisdictions appear to be at a crossroads. In an attempt to attract and retain fund managers from the U.S., the U.K., Japan, Switzerland and other "money center" jurisdictions, offshore jurisdictions have had to satisfy the infrastructure demands of fund managers, address anti-money laundering and fraud considerations, and, at the same time, find ways to raise additional revenue to support the implementation of their policies, while still holding themselves out as "low tax" or "no tax" jurisdictions. In the last few months, we have seen a significant amount of new law being passed in offshore jurisdictions - some of which seek to raise revenue through additional filing fees and annual updating fees, while others seek to attract new fund managers by streamlining the organization process for new funds.

To help fund managers with offshore funds stay apprised of changes to the laws in these jurisdictions, we have summarized below recent developments in some of the more popular...