Cayman Islands Offshore Hedge Funds: The Basics

What is an offshore hedge fund, what is its purpose, and how can it benefit the Cayman Islands investor?

An offshore hedge fund is a structure used by hedge fund managers to attract offshore investors. The main reason for investing in offshore hedge funds is nearly always to take advantage of minimal or zero taxation in the place where the fund is registered and remove liability for taxes in the place where the investor is living; a lawful strategy usually referred to as ‘tax efficiency’, or even ‘tax avoidance’ (but not ‘tax evasion,’ which is illegal).

Basically, a hedge fund is where individual investors pool their money for investment by a fund manager paid to eliminate risk and maximize profits. Benefits to the investors, aside from zero tax on profits, include asset and wealth security, access to international trading and investment opportunities, a high level of privacy in dealings, and the ability to conduct business entirely electronically, no matter where you are based.

Hedge funds are practically always established in low or zero tax jurisdictions — which is how they don’t have to pay domestic corporate taxes. But offshore hedge fund investors are usually liable for taxes in their country of residence on the income they receive from the fund.

The Cayman Islands is considered the most popular offshore jurisdiction in the world, and Cayman Islands hedge funds, the leader in offshore hedge funds. More than 10,000 offshore hedge funds are currently registered with the Cayman Islands Monetary Authority (CIMA).

Stamp duties, licensing fees and import duties make up the bulk of the Cayman Islands’ government revenue, not direct taxation. So putting your money to work in a jurisdiction where there is no income tax, corporate tax, capital gains, or inheritance taxes is a good ‘hedge’ bet.

The offshore hedge fund structure is designed for those who already have wealth. An investor has to be accredited. In order to invest in one, meaning an individual investor must have at least US$1,000,000 of net worth (or at least US$200,000 in annual income). In return, those who meet eligibility requirements enjoy professional money management, offshore tax rules, and lower expenses.

Being subject only to the tax rules of the offshore jurisdiction means that overseas-based investors are not required to meet residence-country tax requirements on their profits from offshore hedge funds. This ability to make money outside domestic financial rules gives hedge funds more freedom to find money-making opportunities in many different forms of investment — from real estate to forex to commodities.

There are two types of offshore funds in the Caymans — registered and non-registered. Registration with CIMA is required if the fund is open-ended and has more than 15 investors. Registration is also required if the fund has fewer than 15 investors and the investors do not have the right to appoint or remove a director.

There is no requirement to register a fund with CIMA otherwise. This is usually the case with private equity funds as well as offshore incubator hedge funds.

Funds registered with CIMA must pay a recurring annual fee of US$3,048 (currently) to CIMA, must have at least two directors who are individuals (though they are not required to be resident in the Cayman Islands), must hire a Cayman-based auditor, and must place a minimum initial investment of at least US$100,000.

A limited liability company or limited partnership easily set up by Cayman corporate services providers is the usual method of setting up an offshore fund. Investors putting money into a fund structured as a limited liability company receive shares corresponding to their investment level, redeemable according to the company’s articles of association.