Offshore jurisdictions have historically been popular places to incorporate investment holding vehicles. The corporate law of offshore jurisdictions is typically flexible and free from the requirement to prepare audited financial accounts. Offshore jurisdictions are also well served by professional service providers such as lawyers, accountants and corporate secretarial providers.
Offshore holding companies forming part of a private wealth structure have typically been unregulated. Historically it has only been mutual funds which have needed to register with the local authorities and comply with ongoing reporting requirements. This has potentially changed with the introduction of private funds laws in many offshore jurisdictions, including the Cayman Islands, British Virgin Islands (‘BVI’), the Bahamas and Bermuda. These new regulations potentially impact upon offshore entities which are managed by single family offices. This includes Singapore based family office structures which have been developed around local tax incentives such as the Enhanced-Tier Fund incentive (‘ETF’) of Section 13X of the Income Tax Act (Cap 134) (‘ITA’).
1. The context
Offshore jurisdictions have been subject to increased international pressure, and have been required to adopt measures such as economic substance rules and facilitate access to beneficial ownership information. Like the rest of the world, the offshore jurisdictions have adopted the common reporting standard which is now a global norm for the exchange of information alongside FATCA. The regulation of private funds is consistent with this trend towards greater scrutiny.
The regulation of private funds is not problematic per se. It is however the ongoing compliance obligations which this entails which could be expensive, and in the case of private wealth vehicles, of little practical benefit to the owners of these entities. This includes a requirement to prepare audited financial statements, and to custodise financial assets. Particularly for those vehicles with unlisted investments, an audit requirement is potentially a significant cost imposition. This could give rise to a requirement to fair value investments and even to prepare consolidated accounts where an investment is a sufficiently large stake in an underlying business or structure.
2. What is a private fund?
The definition of such a regulated private fund is quite broad and there are differences between the various regimes of the offshore jurisdictions. For example, the Cayman Islands Private Funds Law defines a private fund as exhibiting the following characteristics:
• its principal business is the offering and issuing of its investment interests;
• a pooling of investor funds;
• a spreading of investment risks; enabling investors to obtain profits or gains from investments;
• no day-to-day control by investors;
• the management of assets by an external manager for a reward based on assets or profits
While at first blush, the above definition seem to be targeted at institutional funds with third party investors, we understand that family fund vehicles can also fall within scope in certain instances. This requires a careful review of the characteristics of the relevant family fund vehicles, and the investment management relationships between the family fund vehicles and a family office. Where a family fund is caught within scope of the above definition, we understand that it is possible to rely on certain specific exemptions which have unfortunately not been yet been clearly defined or elaborated administratively.
The other offshore jurisdictions including the BVI, the Bahamas and Bermuda have respectively enacted regulations setting out their own definitions on what constitutes a private fund.
3. What to do?
Where a family fund is considered to be a private fund, and cannot avail itself of any exemptions, it has to register with the relevant authorities. In the BVI and Cayman Islands the registration deadlines are fast approaching – 1 July 2020 for BVI funds, and 7 August 2020 for Cayman Islands funds. Thereafter, the funds will need to comply with various annual ongoing obligations, such as engaging an auditor in the Cayman Islands for Cayman Islands funds, and paying annual registration fees for each entity. The overall maintenance and compliance costs will increase significantly where a family has multiple family fund vehicles.
Considering the imminent deadlines, families and family offices should certainly seek proper advice as soon as possible to confirm if their offshore holding companies would fall within or outside the scope of these new laws. The introduction of these rules may present a further impetus to consider the onshoring of existing offshore structures or an increasing focus on using domestic investment vehicles where possible. For families having an existing nexus with Singapore, the solution may include consolidating the ownership of assets into domestic fund vehicles which are approved under either the Singapore Resident Fund Scheme of Section 13R of the ITA or under the ETF.