The application of offshore entities and funds is extensive, but within offshore jurisdictions, the term offshore fund is typically limited to purely open-ended investment funds. This means investors can redeem their fund shares within the time frame specified in the fund contract, classifying it as an equity investment rather than a debt investment. This is primarily because closed-ended investment funds (i.e., funds that cannot be redeemed at any time) and funds structured as debt are generally not subject to conventional investment fund regulations, and therefore are not considered funds in the strictest sense.
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Structure
The main fund structures involved in managing offshore funds include:
- Offshore corporations
- Partnerships (usually limited partnerships)
- Unit trusts in offshore jurisdictions (less common)
A key feature is that investors hold equitable interests (i.e., shares, partnership interests, or units).
According to the regulations in most countries, offshore fund operations require dedicated staff, and most of this staff must meet the qualification requirements of local laws. Offshore fund personnel include:
- Fund administrator
- Fund manager
- Custodian
- Prime broker
- Authorised representative (required in some jurisdictions, such as the BVI)
In some cases, the absence of certain personnel is acceptable. For example, a feeder fund in a master-feeder structure usually does not need to appoint a custodian. Alternatively, if the prime broker also performs the duties of a custodian, an additional custodian is not required.
Most jurisdictions also require offshore funds to submit audited accounts to the regulatory authorities annually. Nearly all jurisdictions require the directors of offshore funds to meet relevant regulatory standards, and some jurisdictions have additional qualification requirements.
Global Market Share
The market share of offshore funds is usually measured by the number of funds or by Assets Under Management (AUM).
According to research from a top UK financial consulting firm, the Cayman Islands dominate the market share for hedge funds (a typical offshore fund product).
| Offshore Hedge Funds — Market Share | |||
| Number of Funds | AUM | ||
| Offshore Jurisdiction | Share | Offshore Jurisdiction | Share |
| Cayman Islands | 45% | Cayman Islands | 52% |
| Delaware | 20% | Delaware | 22% |
| British Virgin Islands | 10% | British Virgin Islands | 11% |
| Ireland | 8% | Jersey | 5% |
| Bermuda | 6% | Bermuda | 4% |
| Malta | 5% | Ireland | 3% |
| Luxembourg | 4% | Luxembourg | 3% |
| Jersey | 2% | Guernsey | <1% |
| Guernsey | <1% | Isle of Man | <1% |
| Isle of Man | <1% | Malta | <1% |
Private equity funds are subject to similar liquidity constraints as hedge funds, but the data is strikingly different. Delaware accounts for more than half of the market share in both the number of funds and AUM.
| Offshore Private Equity Funds — Market Share | |||
| Number of Funds | AUM | ||
| Offshore Jurisdiction | Share | Offshore Jurisdiction | Share |
| Delaware | 64% | Delaware | 72% |
| Cayman Islands | 11% | Guernsey | 11% |
| Guernsey | 7% | Cayman Islands | 11% |
| Luxembourg | 9% | Jersey | 5% |
| Jersey | 6% | Luxembourg | 4% |
| Ireland | 3% | Ireland | 1% |
| Bermuda | <1% | Bermuda | <1% |
| British Virgin Islands | <1% | British Virgin Islands | <1% |
| Isle of Man | <1% | Isle of Man | <1% |
| Malta | <1% | Malta | <1% |
Offshore Fund Regulation
Offshore Regulation
Most mature offshore jurisdictions have similar regulatory frameworks for offshore funds. Typically, a two-tiered regulatory system is adopted, with different requirements for funds offered to the public and for private funds.
Funds offered to the public are generally highly regulated because their potential investors are ordinary investors.
Private funds, also known as private or professional funds, are typically considered to have sophisticated investors due to the nature of their products. For example, their minimum initial investment requirement might be as high as US$100,000, or investors may need to prove they are “professional investors.” Alternatively, the fund might be designed for a small, select group of investors, with its constitutional documents limiting the number of investors to, for instance, 50 or fewer. Most offshore jurisdictions have stricter regulatory requirements for such funds, and thus their numbers are relatively small.
The establishment of offshore funds is often linked to the regulatory system rather than the tax system. The relative lack of regulation on leverage and investment strategies in offshore jurisdictions has encouraged the establishment of high-risk funds, such as hedge funds, in these locations.
Onshore Regulation
An increasing number of developed countries are looking to implement direct regulation of offshore funds marketed to investors within their borders. For example, in 2011, the European Union issued the Alternative Investment Fund Managers Directive (AIFMD), which requires offshore funds to comply with extensive regulatory rules in order to be marketed to investors within the EU.
Offshore Fund Tax Requirements
Offshore Requirements
Generally, the jurisdiction where an offshore fund is registered does not impose any direct tax on the fund’s profits, nor does it levy any withholding tax or similar income tax on the distribution of fund income. However, the fund’s investment activities in other countries may generate taxes. For example, if a fund incorporated in the Cayman Islands realizes capital gains from a transaction in New York, it will likely be subject to U.S. capital gains tax. Similarly, if a person residing in the UK invests in a Guernsey fund, they will be taxed by the UK government on the income and capital gains received, as required by UK tax law, even though Guernsey does not impose any tax.
Onshore Requirements
Different countries have different tax regimes for income generated from offshore funds. U.S. citizens are generally taxed on investment income earned outside the United States, regardless of whether they reside in the U.S. or whether their income is repatriated to a U.S. account. Under UK tax rules, the taxability of overseas income depends on the taxpayer’s residency status and whether the funds are remitted to the UK.
There is a common public perception that offshore investment funds are associated with tax evasion, which has led governments to enact relevant laws. The most prominent example is the U.S. Foreign Account Tax Compliance Act (FATCA). Additionally, an increasing number of countries have signed the Multilateral Convention on Mutual Administrative Assistance in Tax Matters (MAAC) in recent years, which binds almost all major offshore fund companies.
Risks and Advantages
Offshore funds can be associated with higher risks. Since the fund is registered in a foreign country, investors may not be fully aware of the fund’s terms and details, exposing their capital to the risk of loss. Additionally, offshore funds may follow different rules and regulations than standard investments, which can lead to a higher risk of capital loss.
Similarly, because they are registered abroad, offshore funds also have corresponding advantages. These include but are not limited to:
- More lenient regulations, making it easier to establish and manage the fund.
- Most countries where offshore funds are based do not tax fund income, which facilitates the reinvestment of fund profits.
- Significantly lower operating costs, and management fees can also be lower.
Conclusion
Although offshore funds offer significant competitive advantages, the lack of robust regulation in some offshore jurisdictions can expose investors to the risk of investment fraud. When investing funds in an offshore account, it is crucial to conduct enhanced due diligence, especially when dealing with lesser-known fund companies or those registered outside of established offshore financial centers.
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