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Offshore
Mutual Funds
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John
Schroder answers some commonly asked questions about offshore Investments
and Banking
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Many of our clients are very interested
in hearing about the investment opportunities mentioned in our newsletters
and daily updates. Of course, some clients are unfamiliar with certain
types of investment terms, have a fear in general about offshore investments,
or simply are not aware of the mutual fund investments that are available.
The reality is that well known companies such as Fidelity Investments,
Scudder Funds, Templeton, Alliance, Invesco, and other very good investment
firms all offer tax-free offshore mutual funds.
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What
is a Mutual Fund, Pooled Fund or Open Ended Investment Trust?
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Most American investors are very familiar
with mutual funds, but for those that are not, here is a brief explanation.
A mutual fund is basically a type of investment vehicle that allows individual
investors with a like minded interest to pool their money and have the
benefit of professional money management. The professional manager has
the responsibility of selecting stocks, bonds or other investments that
are consistent with the fund’s goal or objectives. As an example,
investors participating in the GT Global Healthcare Fund are doing so because
they want to own a portfolio of stocks involved in the healthcare industry.
In reality, they are a part owner (along with the other fund investors)
of a very large investment portfolio. The portfolio may be a collection
of 50 companies worldwide that are involved in the healthcare industry.
To duplicate such a portfolio themselves, investors would need to commit
a great deal of time and capital. But, with an investment of only $25,000
in the fund, the investor has the benefits of instant diversification and
the knowledge that a professional advisor is managing the portfolio for
them. Naturally, the fund manager receives a salary from the mutual
fund firm and may also receive a bonus that is directly related to how
well he or she manages the portfolio for the investors. All mutual
fund companies charge a management fee for the services they are providing.
Even so-called no load companies are getting their money from somewhere.
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The equivalent British term to the
American “mutual fund” is “pooled fund” or “open investment trust”.
In reality, the open-ended trusts that can be seen listed in the London
Financial Times are the same type of investment vehicles as the American
“mutual fund”. To be sure, there are many more terms and detailed
explanations that go along with this. The purpose here is for the
reader to have a basic understanding of a mutual fund type of investment.
I also want you to be aware that there are a number of investments in Europe
that have a different name, but in essence work the same way as something
you are very familiar with.
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Why
are Offshore Mutual Funds Tax-Free?
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Well, the explanation for this is
quite simple. Just like some jurisdictions permit interest from bank
accounts to be tax exempt, the same is true for mutual funds. Some
of the more popular offshore mutual fund jurisdictions, such as the Cayman
Islands, Bahamas, Bermuda, Channel Islands or the Isle of Man permit mutual
funds to be exempt from local taxation as long as the investors are not
residents of these locations. Mutual fund companies use this to their
advantage. All of the well-known American mutual fund companies mentioned
earlier have their funds registered and based in one of these locations.
As an example, The Fidelity Investments Offshore North America Fund might
be the very same fund as the popular Magellan Fund or Puritan Fund. The
only difference is that the fund is domiciled and is operated offshore.
As a result, there is no tax on capital gains or dividends for the shareholder.
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Why
haven’t I heard about this type of investment before?
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Three reasons: fear, aggravation
and the S.E.C or Securities and Exchange Commission. The US Securities
and Exchange Commission prohibits offshore or non-US registered funds from
soliciting US investors. In theory, this is to protect US investors
from unscrupulous and unregulated offshore fund companies and in my opinion
is a valid regulation. The regulations and requirements in some jurisdictions
regarding offshore fund companies range from a highly regulated environment
to none at all. Investors therefore must investigate a fund company
thoroughly and do their homework. There are some excellent companies
operating offshore, such as Global Asset Management, Baring Asset management,
Invesco-GT Global, Fidelity Investments, and then there are some crooks.
You must certainly separate the good from the bad.
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In all honesty, there are also a
number of very good trust or fund companies from Europe that simply do
not want to be bothered with all of the paperwork and filing requirements
of the S.E.C, just so they can market their funds in the US. Part
of this also has to do with taxes. Many European funds operate on
what is known as a roll-up basis. This means that capital gains and
dividends are automatically reinvested back into the fund, pushing up the
share price in the process. No distributions are actually made as
with the US funds. These type of funds are actually tax deferred because,
the investor does not have a tax consequence until they redeem their fund
shares five years later, ten years later or whenever. You can be sure that
the IRS does not like this arrangement and the European fund companies
are not about to change the way they operate just to please the IRS.
If you currently own shares in a US mutual fund, even if you request automatic
re-investment of your capital gains and dividends, you know that your annual
capital gains are reported and that you must pay tax on it. This
is regardless of whether or not the actual share price of the fund has
changed or whether or not you physically received a check from the fund.
This has got to be one of the greatest tax scams in history and the IRS
loves it. You are actually paying tax twice on your US mutual fund
investment. Once every year that you own the fund and of course again
when you redeem your shares.
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The other reason that you may not
have heard about these offshore funds is fear. Even though offshore
funds cannot solicit US investors directly, US investors are certainly
permitted to solicit them. Meaning, it is perfectly legal for you
to own shares in any of the funds offered from Luxembourg, Isle of Man,
Cayman Islands, Honk Kong and elsewhere. However, recent hassles
or scare tactics regarding tax reporting issues and money laundering efforts
have made many offshore fund companies refuse to accept American clients.
This is especially true with the investment companies located in Europe.
Most of these companies are tired of being harassed by the IRS or the SEC
to cooperate with tax reporting or to turn over investor lists. If it is
not a requirement in their own country, why should they do it just because
3% of their clients are American? It is unfortunate, but this is how the
US government agencies have gotten around the constitution. It is
far easier, and technically legal, to put the fear of God into a foreign
company, so much so, that they will not take American clientele.
Remember what I mentioned previously.
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It is perfectly legal for a US citizen
to own shares in a foreign or offshore mutual fund, annuity or to have
an offshore bank account. The problem today is finding a company
that is not afraid of the IRS or the SEC and that will take an individual
US citizen as a client. I do know of a few companies in Europe that
will do it, but they are the exception to the rule.
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How
Can Investors participate in an Offshore Mutual Fund?
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There are two problems that both
can be addressed by using the Offshore Trust, Foundation or Company structure.
One problem is something already discussed. That is the refusal of
many offshore fund companies to take US citizens or residents as clients.
While many firms have a fear about this, for the reasons discussed, they
have absolutely no problem with a Trust or Non-US company as the shareholder
or beneficial owner of the fund. So, while the US citizen is shunned,
a Panamanian Corporation or Trust from the Bahamas is welcome with open
arms as a shareholder.
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The second problem US investors
have is taxes. Even if you find an offshore mutual fund that will
take you as a client, and while it is perfectly legal under US law for
you to own such an investment, you still are required to pay tax to the
US government. This is true regardless of the fact that there is
no tax liability in the jurisdiction where the fund is domiciled or if
the fund is a SICAV or “roll-up” type fund that does not make annual distributions.
The answer again is to own such an investment through a properly arranged
offshore entity.
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When you factor in the tax savings,
asset protection benefits and availability of some excellent investment
opportunities; Offshore Mutual Funds, SICAV Funds, and Unit Trusts from
the Isle of Man or the Channel Islands are extremely appealing and offer
the possibility of returns not found in the North American market.
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For additional information regarding
tax-free offshore mutual funds, please contact us.
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