1st February 2017
For many years the benefits of setting up offshore structures were clearly defined and throughout the last 20 years the offshore funds and SPV administration industries have thrived. More recently however, the offshore financial centres have faced a number of headwinds and in fact it is not uncommon for onshore based managers to contemplate whether it is now worth the time and effort to go offshore.
Why move offshore?
Initially, the domiciliation of funds to offshore jurisdictions such as Cayman became popular due to relatively light regulatory regimes and the beneficial tax rates available to investors such as the ability to transfer units without paying Stamp Duty Land Tax or ability of an onshore manager to charge the fund management fees without VAT. For these reasons, there was a massive push to domicile funds offshore irrespective of the underlying assets, investment strategy or total funds being raised.
In the early years what quickly came to light was that not all offshore jurisdictions were fully equipped to service these funds from a technical understanding and operational perspective. Also, some jurisdictions did not have the necessary infrastructure to provide the fund domiciliation, administration and accounting services required by these funds.
In some instances, the costs of running offshore structures outweighed the tax benefits especially in the case of smaller fund raises. This was particularly visible where subsequent deals required new entities to be set up in an established structure. Furthermore, if deals spanned several jurisdictions thought had to be given to tax harmonisation and whether the tax benefits could be rolled up ultimately to the fund rather than being blocked lower down the structure.
A mature and experienced industry
As one would expect, with the industry maturing, there was increased scrutiny from the regulators. Offshore presence was no longer a rubber stamping exercise but required an understanding of the ultimate beneficial owners, involvement in day to day running of the fund and knowledge of the underlying asset classes as well as adherence to various anti money laundering, compliance and regulatory filing requirements.
Certain jurisdictions were more open to fund structures than others. For example, they provided different platforms involving different levels of regulatory scrutiny to establish smaller funds vs larger funds.
Effective management and control
Certain regulators were more heavily involved in the funds industry relative to others. Heavy involvement included exertion of pressures on fund managers and service providers to demonstrate that there was “actual substance” in the offshore jurisdiction. This required a detailed understanding of where the effective central management and control of the structure lay and whether the fund managers were actually involved in the day to day running of the fund. This required a distinction to be made between how much investment advice was being provided on shore vs offshore. Base erosion and profit shifting (“BEPS”) planning have accelerated this trend.
This in turn required a determination of the split of services underpinning the fund structure and ultimately if it would be subject to onshore taxation rules and classed as an offshore shell structure. Transfer pricing soon became important especially to determine services being provided on and off shore.
Regulators have created accountability
In addition, not all investors are comfortable with all off shore jurisdictions although some investors acknowledge that the presence of a regulator gives additional comfort to certain investors (such as institutional investors) that the fund managers are being held accountable and responsible to regular scrutiny.
Therefore in summary, some fund managers are questioning whether going offshore is really worth it. Those with existing offshore infrastructure are likely to continue using the offshore model but for new promoters, if the benefits are marginal they are just as likely to keep the structure simple by keeping it onshore.
From a practical perspective, we have seen a few clients requesting for employees to work directly for the client on a part time basis to enable the client to provide substance in the offshore structure. We have also run training sessions for clients to show them how directors’ meetings should be structured in terms of frequency, information requests and documentation approval processes.
Head of UK private equity
T: +44 20 3597 7927