Offshore Mutual Funds

reasons to expatriateMany 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,  Templeton, Alliance, and other very good investment firms all offer tax-free offshore mutual funds.  In addition, there are also some excellent investments firms in countries such as the UK and Luxembourg that offer mutual funds that Americans especially have never heard of simply because these firms really do not want to be bothered registering them in the US.  But, they can be sound additions to your investment portfolio.  In addition, keep in mind that many of these kinds of mutual funds or investment funds may also be available through a number of retirement annuity products as well.  There is one very good 100 plus year old insurance company from Europe offering this very same kind of opportunity, so they are out there if you know where to look.     

What Is A Mutual Fund?

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 adviser 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.

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.  

Why Are Offshore Mutual Funds Tax Free ?

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.   

Why Have You Not Heard Of These Investments Before ?

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, Fidelity Investments, and then there are some crooks.  You must certainly separate the good from the bad.  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. 
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.  However, 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.   

How Can Investors Participate In An Offshore Mutual Fund ?

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.  However, another option is of course for the investor to obtain another citizenship and another passport.  In this regard, he or she would be investing individually (and not necessarily via an offshore company or trust) albeit as a citizen from another country (see our other articles about dual citizenship and obtaining a second passport).

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.  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.