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Legal analysis by Harneys lawyers

The case for offshore: What is the driving force behind structuring through offshore structures, and how does this benefit Africa?

15 August 2016

Quite unexpectedly, the Panama Papers was raised at a recent society event I attended in Zimbabwe, and while the popular press has permeated even to the most unexpected areas – often without an accurate consideration of the facts – it made me think about how much is truly understood about the driving forces behind using offshore structures, and how alternative funds benefit Africa. Contrary to what one might read, using offshore structures extends well beyond tax neutrality considerations. This article considers the advantages of structuring through established and reputable offshore jurisdictions with a particular focus on the Cayman Islands.

Key advantages of offshore structuring

Briefly, these can be summarised as follows:

Turning now to the alternative funds industry, this is geared towards sophisticated investors including pension funds, charities and development finance institutions. It offers these groups access to professional expertise, portfolio diversification, economies of scale and opportunities that they might not otherwise have through investment in alternative investment types by the pooling of funds. The beneficial knock-on effects from this industry are obvious in Africa and include the flow of much-needed investment into African countries. This helps boost economies, create employment and develop infrastructure. However, both alternative investment managers and investors have certain expectations for the jurisdictions their funds are domiciled in. If these are not met, the investment is unlikely to proceed. Cayman is the leading jurisdiction for the domicile of alternative funds, with four of its key attributes (tax neutrality, transparency, flexibility and reliability) now being considered in greater detail.

Tax neutrality is a cornerstone of successful fund structuring. A common misconception about tax neutrality is that it exempts funds from paying any tax. The truth is that tax neutrality ensures that there is no duplicate layer of tax, which preserves the attributes that an investor would have if investing directly in the underlying assets. Investors are still liable for domestic tax per the laws of their home jurisdictions. Additionally, there are likely to be income and realised capital gains taxes arising in the jurisdiction where the fund invests. Tax neutrality simply removes a third layer of tax, which, if imposed, would threaten the viability of collective investment. Taxing a fund investing in Africa would make risk-adjusted returns less appealing and likely curtail the much-needed flow of foreign direct investment into African countries.
Transparency is becoming increasingly important in today’s world. A common misconception about offshore structures is that they lack transparency. In fact, Cayman has been at the forefront of adopting various transparency initiatives, including FATCA, UK FATCA and the CRS. As a result, reported information relating to tax residency is shared between Cayman and the governments of over 90 jurisdictions. In Cayman investors must complete online self-certification forms on subscription with the fund registering and filing periodic reports with the Cayman Islands Tax Information Authority. This, coupled with comprehensive and strict anti-money laundering laws and KYC rules and regulations, means that reputable offshore jurisdictions such as Cayman are conduits for bona fide investment. The OECD’s whitelisting of Cayman, and its compliance with Financial Action Task Force standards are testament to this.

Alternative funds, unlike their more heavily regulated retail mutual fund counterparts, often require a more flexible environment in which to successfully pursue their investment strategies. Frequently, alternative funds require the ability to restrict or prohibit redemptions, invest on a “long” or a “short” basis, employ hedging techniques and leverage their investments through gearing. Therefore, their jurisdiction of domicile must allow for this and also demonstrate professionalism, responsiveness, simplicity, flexibility, expertise, effective and balanced regulation and cost effectiveness. These attributes provide investment managers, investors and other market participants with the confidence they need in an offshore fund jurisdiction and is something that jurisdictions such as Cayman are well positioned to do.

For any alternative fund to have a chance of success, it needs to be able to attract capital. Fund raising is one of the key challenges that alternative investment managers face in today’s environment and following on from this, it seems only logical that an alternative fund is structured with a view to achieving a successful fund raising. This includes choosing a jurisdiction of domicile that demonstrates the attributes set forth in this article and meets any specific needs of target investors. Cayman has a track record of reliability that has been built up over a sustained period of time and which was aptly demonstrated by the jurisdiction successfully navigating the numerous challenges thrown up during the global financial crisis and its aftermath. Given Cayman’s predominance as the jurisdiction of choice for alternative funds, the Cayman courts have adjudicated upon a wide range of issues faced by the industry and passed precedent setting judgements that are respected globally. This, coupled with a deep pool of highly respected and experienced service providers (many of which have offices in the major financial centres to meet client needs) and an effective and efficient regulator and legislature means that Cayman has the confidence of and is familiar to most alternative fund investors across the globe.

In conclusion therefore I contend that structuring through reputable offshore jurisdictions such as Cayman, whether it be for the establishment of alternative funds or otherwise, is necessary in our increasingly globalised economy. Such structuring facilitates the flow of capital and encourages investment, particularly in Africa, where many countries are viewed as frontier, rather than emerging. Offshore structures are here to stay as conduits for investment, and the function that they fulfil has to be beneficial to Africa.

A version of this article was originally published in August 2016 in Africa Funds Global and is available here