Tax neutrality essentially means that the country where the fund is formed, such as the Cayman Islands, does not impose its own duplicative layer of taxes on the fund. However, that does not mean that investors in tax neutral fund registered in offshore jurisdictions such as the Cayman Islands do not pay taxes. Tax neutral status is not unique to offshore funds. There are tax neutral fund categories in the USA and the UK.
What sets offshore funds - and particularly, offshore alternative funds - apart is the combination of tax neutrality, investment flexibility and sophistication allowed by offshore alternative fund structures. This is what makes offshore alternative funds so attractive to sophisticated investors.
As funds are often set up as a company or a partnership, those companies and partnerships can be subject to a separate tax charge in the place where they are formed. This means that investors could effectively (and unfairly) be taxed twice on the same income and capital gains. Such double taxation would render most funds uneconomic and defeat their purpose of assisting investors.
Tax neutrality in the jurisdiction where the fund is established - whether onshore or offshore - ensures that such duplication of taxation does not occur, preserving the attributes that an investor would have if investing directly in the underlying assets rather than through an alternative fund. A fund should be seen as an aggregation of capital rather than a discrete taxable entity and such characterization underpins many of the rules allowing exemption for funds in general.
Leading the way in tax transparency and information exchange the Cayman Islands have signed agreements allowing tax information exchange with more than 90 countries. We now also automatically share tax data as part of US FATCA and Common Reporting Standards, also having signed onto the country-by-country reporting principles under the OECD’s base erosion and profit-sharing process.
For more information on doing business in the Cayman Islands please contact
David Walker, Managing Partner or
Candice Czeremuszkin, Partner.