HEDGE FUNDS
LAWS FOR ADVISERS & FUNDS: INTERNATIONAL LAW

US and International (“Offshore”) Hedge Funds

The corporate structure of a hedge fund depends primarily on whether the fund is organized under U.S. law (“domestic hedge fund”) or under foreign law and located outside of the United States (“offshore hedge fund”). Limited partnerships, LLCs, and business trusts generally are not separately taxed and, as a result, income is taxed only at the level of the individual investor. Each of the three forms also limits investor liability. LLCs offer the additional benefit of limited liability for fund advisers, but some states and foreign countries tax LLCs as corporations. The investment adviser of a domestic hedge fund often operates a related offshore hedge fund, either as a separate hedge fund, or often by employing a “master-feeder” structure that allows for the unified management of multiple pools of assets for investors in different taxable categories.

U.S. Hedge Funds

Domestic hedge funds usually are organized as limited liability companies and limited partnerships to accommodate investors that are subject to U.S. income taxation. The fund’s sponsor typically is the general partner and investment adviser. The sponsor typically also handles marketing and investor services. Domestic hedge funds typically maintain contractual relationships with one or more broker-dealers, which provide clearance and settlement and financing services, and may provide a variety of services. A domestic hedge fund also may employ executing brokers, accountants, lawyers, custodians, and a variety of incidental services administrators, placement agents, registrars, and transfer agents. Domestic hedge funds typically do not have a board of directors or any oversight body analogous to the board of directors of a registered investment company.

The master fund usually is organized as a corporation, such as an international business company, under non-U.S. law. It offers shares to one or more domestic feeder funds and one or more offshore corporate feeder funds, all of which share common investment strategies and objectives.

Offshore Hedge Funds

Offshore hedge funds typically are organized as corporations in countries such as the Cayman Islands, British Virgin Islands, the Bahamas, Panama, the Netherlands Antilles or Bermuda.Generally, offshore funds generally attract investment by U.S. tax-exempt entities, such as pension funds, charitable trusts, foundations, and endowments, as well as by non-U.S. residents. Because they may be subject to taxation if they invest in domestic limited partnership hedge funds, U.S. tax-exempt investors favor investments in offshore hedge funds. Offshore hedge funds may be organized by foreign financial institutions or by U.S. financial institutions or their affiliates. Sales of interests in the United States in offshore hedge funds are subject to the registration and antifraud provisions of the federal securities laws.

Offshore hedge funds typically contract with an investment adviser, which may employ a U.S. entity to serve as sub adviser. An offshore hedge fund often has an independent fund administrator, also located offshore, that may assist the hedge fund’s adviser to value securities and calculate the fund’s net asset value, maintain fund records, process investor transactions, handle fund accounting, and perform other services. An offshore hedge fund sponsor typically appoints a board of directors to provide oversight activities for the fund. These funds, especially those formed more recently, may have directors who are independent of the investment adviser.

Under U.S. income tax laws, a tax-exempt organization (such as an ERISA plan, a foundation, or an endowment) engaging in an investment strategy that involves borrowing money is liable for a tax on “unrelated business taxable income” (“UBTI”), notwithstanding its tax-exempt status. The UBTI tax can be avoided by the tax-exempt entity by investing in non-U.S. corporate structures (i.e., offshore hedge funds).

We are experts in international hedge funds and tax. Here are just a few of our leading articles:

Structuring and Financing International Operations Using Hybrid Entities and Tax-Efficient Financing Practical U.S./International Tax Strategies (Jan. 15, 2004). Click here.

Hedge Fund Compensation Arrangements. Practical U.S./Domestic Tax Strategies (Dec. 2003). Click here.

U.S. Inbound Investment – The Portfolio Interest Exemption. Practical U.S./International Tax Strategies (Dec. 15, 2003). Click here.

Foreign Futures Planning: The 60/40 Question. Practical U.S./International Tax Strategies (Sept. 30, 2003). Click here.

Managing Offshore Hedge Funds - A View from the Beach: Practical U.S./International Tax Strategies (June 15, 2003). Click here.

Offshore Hedge Funds - Master/Feeder Compliance Issues: Practical U.S./International Tax Strategies (May 15, 2003). Click here.

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