The master feeder fund allows a fund manager to manage money for a broad spectrum of investors. The master fund is an offshore corporation or trust (but taxed as a partnership only for U.S. tax purposes via a check-the-box election) engages in trading activity. A fund manager will pool money from country-specific feeder funds and invest in the master fund. Trading gains are allocated to the feeder funds based on the percentage assets under management in each feeder fund. A master feeder fund requires (in addition to the master fund) a U.S. limited partnership (or limited liability company) as the feeder fund for U.S. taxable investors and a foreign corporation (or trust) as the offshore feeder for foreign investors and US tax-exempt investors. See Master Feeder Compliance Planning and Managing Offshore Hedge Funds
U.S. Tax Exempt Investors. U.S. tax-exempt investors prefer offshore funds because of more favorable tax considerations. Under U.S. law a tax-exempt investor (such as an IRA, an ERISA-type retirement plan, a foundation, or an endowment) is liable for income tax on "unrelated business taxable income" (UBTI or UBIT) notwithstanding its tax-exempt status. This tax exposure exists when a U.S. tax-exempt investor invests in a fund that trades on margin.
International Investors. When a nonresident has a U.S. brokerage account, interest and dividends earnings are subject to U.S. withholding tax. No U.S. withholding tax should apply to capital gains. Many brokerages will withhold taxes anyway. However, the nonresident (individual or business) can file for a tax refund and then properly structure their trading business to prevent mistakes in the future.
The master feeder structure allows the investment manager to manage money collectively for various types of investors in different investment vehicles without having to allocate trades and while producing similar performance returns for the same strategies. Feeder funds invest fund assets in a master fund that has the same investment strategy as the feeder fund. The master fund, structured as a partnership, engages in all trading activity. In today’s trading environment, a master feeder structure will include a U.S. limited partnership (or limited liability company) for U.S. investors and a foreign corporation for foreign investors and U.S. tax-exempt organizations. The typical investors in an offshore hedge fund structured as a corporation will be foreign investors, U.S.-tax exempt entities, and offshore funds of funds.
Offshore Funds. Hedge funds are set up as offshore or onshore funds to allow for different groups of investors. U.S.-based fund managers who have a client base outside the United States or a U.S. tax-exempt client base will set up offshore. For a fund manager who is a small operator and for whom the extra costs are a major burden, the best location to launch an offshore fund or a master feeder fund is Anguilla. If there is more money in the budget, then the Cayman Islands, the Bahamas, or BVI are a possibility. The most widely used (and most expensive) countries are Bermuda, the Cayman Islands, Guernsey, Hong Kong, the Isle of Man, Jersey, Luxembourg, the British Virgin Islands and Dublin. Mauritius is a favored location for managers with funds invested in India because of a tax treaty between those two countries. Mexican investors favor Singapore. Again, Anguilla is an optimal choice for those that want to avoid the higher costs and longer lead time associated with fund setups in most other countries. These countries have tiered statutory regimes that allow funds to start out as exempt funds and then later upgrade to non-exempt fund status (rarely necessary). Many fund managers use offshore funds to provide privacy to investors.
In those cases where complete investor confidentiality and privacy are necessary, an offshore fund should not accept any U.S. investors (tax-exempt or otherwise) and the fund manager should not be located in the United States. Offshore are organized as corporations or trusts for marketing, tax, and legal reasons. If U.S. investors invest in or effectively control an offshore fund, complex U.S. tax rules (and complicated U.S. filing requirements) are operable (e.g., controlled foreign corporations, foreign personal holding companies, and passive foreign investment companies (PFIC)) and need attention. Although an offshore fund generally does not have state tax issues, some states require partnerships to file state partnership tax returns if they have partners that are state residents. This could result in an offshore fund (e.g., one with a check the box election in effect and a New York feeder fund as an investor), being required to file a state tax return even if it has no U.S.-source income and no ECI. Some of the issues are manageable and others are not and the offshore fund may be better off skipping or significantly limiting the presence of U.S. investors.
U.S. Tax Exempt Investors. U.S. tax-exempt investors prefer offshore funds because of more favorable tax considerations. Under U.S. law a tax-exempt investor (such as an IRA, an ERISA-type retirement plan, a foundation, or an endowment) is liable for income tax on "unrelated business taxable income" (UBTI or UBIT) notwithstanding its tax-exempt status. This tax exposure exists when a U.S. tax-exempt investor invests in a fund that trades on margin.
International Investors. When a nonresident has a U.S. brokerage account, interest and dividends earnings are subject to U.S. withholding tax. No U.S. withholding tax should apply to capital gains. Many brokerages will withhold taxes anyway. However, the nonresident (individual or business) can file for a tax refund and then properly structure their trading business to prevent mistakes in the future.
The master feeder structure allows the investment manager to manage money collectively for various types of investors in different investment vehicles without having to allocate trades and while producing similar performance returns for the same strategies. Feeder funds invest fund assets in a master fund that has the same investment strategy as the feeder fund. The master fund, structured as a partnership, engages in all trading activity. In today’s trading environment, a master feeder structure will include a U.S. limited partnership (or limited liability company) for U.S. investors and a foreign corporation for foreign investors and U.S. tax-exempt organizations. The typical investors in an offshore hedge fund structured as a corporation will be foreign investors, U.S.-tax exempt entities, and offshore funds of funds.
Offshore Funds. Hedge funds are set up as offshore or onshore funds to allow for different groups of investors. U.S.-based fund managers who have a client base outside the United States or a U.S. tax-exempt client base will set up offshore. For a fund manager who is a small operator and for whom the extra costs are a major burden, the best location to launch an offshore fund or a master feeder fund is Anguilla. If there is more money in the budget, then the Cayman Islands, the Bahamas, or BVI are a possibility. The most widely used (and most expensive) countries are Bermuda, the Cayman Islands, Guernsey, Hong Kong, the Isle of Man, Jersey, Luxembourg, the British Virgin Islands and Dublin. Mauritius is a favored location for managers with funds invested in India because of a tax treaty between those two countries. Mexican investors favor Singapore. Again, Anguilla is an optimal choice for those that want to avoid the higher costs and longer lead time associated with fund setups in most other countries. These countries have tiered statutory regimes that allow funds to start out as exempt funds and then later upgrade to non-exempt fund status (rarely necessary). Many fund managers use offshore funds to provide privacy to investors.
In those cases where complete investor confidentiality and privacy are necessary, an offshore fund should not accept any U.S. investors (tax-exempt or otherwise) and the fund manager should not be located in the United States. Offshore are organized as corporations or trusts for marketing, tax, and legal reasons. If U.S. investors invest in or effectively control an offshore fund, complex U.S. tax rules (and complicated U.S. filing requirements) are operable (e.g., controlled foreign corporations, foreign personal holding companies, and passive foreign investment companies (PFIC)) and need attention. Although an offshore fund generally does not have state tax issues, some states require partnerships to file state partnership tax returns if they have partners that are state residents. This could result in an offshore fund (e.g., one with a check the box election in effect and a New York feeder fund as an investor), being required to file a state tax return even if it has no U.S.-source income and no ECI. Some of the issues are manageable and others are not and the offshore fund may be better off skipping or significantly limiting the presence of U.S. investors.
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