Offshore myth busters

Countless considerations are at play when choosing a fund’s home, but contrary to popular belief, exotic loopholes that allow significant tax savings are not what typically drive a fund manager’s domicile choice.  

However the perception that offshore jurisdictions are simply tax havens is an issue some fund managers run up against on the fundraising trail. For example, some investors consider a Cayman-domiciled fund a political risk worth weighing in the GP selection process. As the media and politicians attack Republican presidential hopeful Mitt Romney for keeping his cash in far off locales, a pension investment director might wonder why the state pension plan tacitly endorses the practice within its own investment portfolio. 

Offshore centres as the ‘Wild West’ of the funds’ industry is a myth GPs should dispel. Places like Jersey and Guernsey for years now have been pushing back against allegations of lax regulatory policies and opaqueness. To help set the record straight, a group of researchers investigated just how easy it was to set up an untraceable shell company in 182 countries. “Global Shell Games”, published in September, concluded that contrary to conventional policy wisdom on the subject, “providers based in tax haven countries were significantly more likely to follow the rules, to apply the “Know Your Customer” principle, than those in non-tax haven countries”. 

Furthermore, and even more importantly for any concerned investors, a private equity fund is comprised of a diverse body of LPs (ranging from tax exempt to foreign, from private individuals to public pension funds) that all demand the investment vehicle provides a neutral tax playing field. And in many instances, only an offshore financial centre can provide that neutrality. 

The public may not be tax literate enough to know it, but shielding certain LPs from taxes like “Unrelated Business Income” and “Effectively Connected Income” are legitimate reasons to move funds off shore. In turn institutional investors (like pension plans and endowments) are in better tax positions to provide their beneficiaries returns. 

To be fair, offshore financial centres are tax advantageous, and undoubtedly deprive neighboring mainland jurisdictions from tax revenue. But this criticism loses weight when applied to offshore funds, which as one industry source puts it, are really just a way for a heterogeneous group of investors to effectively remit income and gains back home. As the saying goes, perception is one thing, reality quite another. 

PE Manager will publish an in-depth fund domiciles special in November, busting more ‘myths’ and looking at what various jurisdictions around the globe offer the private funds industry.