The Changing Environment
This article originally appeared in Offshore Funds
Today. To read the magazine in it's entirety please click
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It is timely to look at the current tax and regulatory
initiatives and consider their impact on offshore funds and their
domiciles.
This is currently a very fluid issue. The volume of information
available is vast. We have tried to focus on core considerations
with the objective of identifying the most likely outcome as it
relates to offshore funds and their domiciles.
Why Use An Offshore Fund?
Most successful hedge fund managers attract, and compete for,
international as well as domestic investors. Typically, hedge fund
investors are not retail investors but institutional investors such
as sovereign wealth funds, pension plans, insurance companies,
university endowments and high net worth investors. Whilst many
investors are located in the US or the EU, an increasing number are
located in South America, the Middle East and Asia.
In considering where to domicile its fund to collect up its
international investors, the manager's primary concern is that
it will be acceptable to these potential investors. As such, the
manager must consider the location of the investors, including any
relevant offering restrictions, the countries in which the fund
will invest, the effect of any tax or exchange controls on cash
flows through the fund, the confidence, familiarity and preference
of the investors and trading counterparties in dealing with the
selected domicile, the regulatory position and the quality of the
local service providers.
The international investors will want to invest in a tax neutral
investment fund. They do not want to invest in a hedge fund based
in a jurisdiction where the hedge fund would itself be subject to
tax or exchange controls.
The hedge fund, although domiciled in an offshore financial
centre (OFC), will still be required to comply with the laws on
market manipulation, insider dealing, late trading and short
selling in the jurisdictions in which it trades. Additionally, the
fund itself will pay tax in jurisdictions where it invests and the
investors will be liable to tax in their home jurisdictions in
respect of any distributions received.
How Will the Environment Evolve?
Tax Initiatives
These initiatives are very politically charged and driven by the
obvious concerns in the US and the EU of the potential leakage of
taxable revenues. This issue has received greater prominence
recently due to the global recession and the fiscal deficits which
have led to actual or threatened increases in tax rates and tax
revenue policies.
OECD
The current initiatives are not new. The Organisation for
Economic Co-operation and Development (OECD) began working on its
harmful tax practices project back in 1996. In an OECD 1998 report,
four key factors were identified as the basis for classifying a
country as a tax haven:
no or nominal tax on the relevant income (it was accepted that
this criteria alone was not sufficient to classify a country as a
tax haven);
no effective exchange of information in respect of taxpayers
benefiting from the low tax jurisdiction;
lack of transparency in the operation of the legislative, legal
or administrative provisions; and
the absence of a requirement that the activity be substantial
is important since it suggests that a jurisdiction may be
attempting to attract investment or transactions that are purely
tax driven.
Subsequent work was done to develop the international standards
for transparency and effective exchange of information in tax
matters culminating in the development of the 2002 Model Agreement
on Exchange of Information on Tax Matters. This model has been used
for more than 80 Tax Information Exchange Agreements (TIEAs). This
model is now also endorsed by and reflected in the UN Model Tax
Convention.
In 2008, the OECD made it known that in June 2009, it would be
publishing a "green list" of jurisdictions making good
progress. Then the G-20 process leading up to the recent London
G-20 summit intervened and the whole issue became subject to
extraordinary political pressures.
On 2 April 2009 immediately following the G-20 meeting, the OECD
published its latest findings on OFCs. In its report the OECD
created three tiers of jurisdictions based on the degree to which
each jurisdiction has implemented the agreed international tax
standards for information exchange and co-operation. The three
tiers are:
White - those jurisdictions that have
substantially implemented the internationally agreed tax
standards;
Grey - those jurisdictions that have committed
to the internationally agreed tax standards, but have not yet
substantially implemented then; and
Black - those jurisdictions that have not
committed to the internationally agreed tax standards.
Categorisation as White required an OFC to have entered into at
least 12 bilateral TIEAs.
The core Ogier jurisdictions of BVI, Cayman, Guernsey and Jersey
all fared well: Guernsey and Jersey are listed in the White
category and BVI and Cayman in the Grey category - but the fact
that both BVI and Cayman have significant additional initiatives in
hand should see them re-classified in the White category within a
short period of time.
The G-20 declaration made on 2 April 2009 confirmed that action
will be taken against those jurisdictions which do not meet
international standards in relation to tax transparency. The
counter-measures outlined included:
increased disclosure requirements on the part of taxpayers and
financial institutions to report transactions involving
non-co-operative jurisdictions;
withholding taxes in respect of a wide variety of
payments;
denying deductions in respect of expense payments to payees
resident in a non-co-operative jurisdiction;
reviewing tax treaty policy;
asking international institutions and regional development
banks to review their investment policies; and
giving extra weight to the principles of tax transparency and
information exchange when designing bilateral aid programs.
European Union
The EU contains 27 separate states with a diverse range of
social models and political perspectives. Some states are more
focused on international financial business than others and it is
difficult to build a coherent EU view on tax initiatives by
analysing statements from individual member states. However, the UK
is the mother country to all the pre-eminent common law OFCs and so
it is instructive to analyse its attitude to OFCs in the context of
the current international initiatives.
The UK has launched two reviews. The first, the "Turner
Report", was a review of the financial crisis commissioned by
the Financial Services Authority and is complete. The Turner Report
made it clear that OFCs were not to blame for the financial crisis
nor were they a major contributor to it. The second review, being a
review of British OFCs (the "Foot Review"), was
commissioned by the UK government. The Foot Review will not produce
its final report until the end of 2009, but the likely result is a
continued push for OFCs to meet international standards of
financial regulation, anti-money laundering and the sharing of
financial and tax information.
It should not be overlooked that as a result of the
implementation of the EU Savings Directive, the EU has had the
benefit of a reporting or tax collection agreement with all the
leading OFCs (including BVI, Cayman, Guernsey and Jersey). As a
result there is reporting and accounting to EU member states of
savings income earned by EU nationals outside of their home state.
In the evolving environment we may see the scope of the EU Savings
Directive expanded to include more...
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