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What is a Mutual Fund, Pooled Fund or Open Ended Investment Trust?
Most
American investors are very familiar with mutual funds, but for those that
are not, here is a brief explanation.
A mutual fund is basically a type of investment
vehicle that allows individual investors with a like minded interest to
pool their money and have the benefit
of professional money management. The professional manager has the
responsibility of selecting stocks, bonds
or other investments that are consistent with the fund’s goal or objectives.
As an example, investors participating
in the GT Global Healthcare Fund are doing so because they want to own
a
portfolio of stocks involved in the healthcare
industry. In reality, they are a part owner (along with the other
fund investors)
of a very large investment portfolio.
The portfolio may be a collection of 50 companies worldwide that are involved
in the
healthcare industry. To duplicate
such a portfolio themselves, investors would need to commit a great deal
of time and
capital. But, with an investment of only
$25,000 in the fund, the investor has the benefits of instant diversification
and the
knowledge that a professional advisor
is managing the portfolio for them. Naturally, the fund manager receives
a salary
from the mutual fund firm and may also
receive a bonus that is directly related to how well he or she manages
the portfolio
for the investors. All mutual fund
companies charge a management fee for the services they are providing.
Even so-called
no load companies are getting their money
from somewhere.
The
equivalent British term to the American “mutual fund” is “pooled fund”
or “open investment trust”. In reality, the open-ended
trusts that can be seen listed in the
London Financial Times are the same type of investment vehicles as the
American “mutual fund”.
To be sure, there are many more terms
and detailed explanations that go along with this. The purpose here
is for the reader to
have a basic understanding of a mutual
fund type of investment. I also want you to be aware that there are
a number of investments
in Europe that have a different name,
but in essence work the same way as something you are very familiar with.
Why are Offshore
Mutual Funds Tax-Free?
Well,
the explanation for this is quite simple. Just like some jurisdictions
permit interest from bank accounts to be tax exempt,
the same is true for mutual funds.
Some of the more popular offshore mutual fund jurisdictions, such as the
Cayman Islands,
Bahamas, Bermuda, Channel Islands or the
Isle of Man permit mutual funds to be exempt from local taxation as long
as the
investors are not residents of these locations.
Mutual fund companies use this to their advantage. All of the well-known
American mutual fund companies mentioned
earlier have their funds registered and based in one of these locations.
As an example, The Fidelity Investments
Offshore North America Fund might be the very same fund as the popular
Magellan
Fund or Puritan Fund. The only difference
is that the fund is domiciled and is operated offshore. As a result,
there is no tax on
capital gains or dividends for the shareholder.
Why haven’t I
heard about this type of investment before?
Three
reasons: fear, aggravation and the S.E.C or Securities and Exchange Commission.
The US Securities and Exchange
Commission prohibits offshore or non-US
registered funds from soliciting US investors. In theory, this is
to protect US investors
from unscrupulous and unregulated offshore
fund companies and in my opinion is a valid regulation. The regulations
and
requirements in some jurisdictions regarding
offshore fund companies range from a highly regulated environment to none
at all.
Investors therefore must investigate a
fund company thoroughly and do their homework. There are some excellent
companies
operating offshore, such as Global Asset
Management, Baring Asset management, Invesco-GT Global, Fidelity Investments,
and then there are some unscrupulous firms.
You must certainly separate the good from the bad.
In all honesty, there are also a number
of very good trust or fund companies from Europe that simply do not want
to be bothered
with all of the paperwork and filing requirements
of the S.E.C, just so they can market their funds in the US. Part
of this also has
to do with taxes. Many European
funds operate on what is known as a roll-up basis. This means that
capital gains and dividends
are automatically reinvested back into
the fund, pushing up the share price in the process. No distributions
are actually made as
with the US funds. These type of funds
are actually tax deferred because, the investor does not have a tax consequence
until they
redeem their fund shares five years later,
ten years later or whenever. You can be sure that the IRS does not like
this arrangement
and the European fund companies are not
about to change the way they operate just to please the IRS. If you
currently own shares
in a US mutual fund, even if you request
automatic re-investment of your capital gains and dividends, you know that
your annual
capital gains are reported and that you
must pay tax on it. This is regardless of whether or not the actual
share price of the fund
has changed or whether or not you physically
received a check from the fund. This has got to be one of the greatest
tax scams
in history and the IRS loves it.
You are actually paying tax twice on your US mutual fund investment.
Once every year that you
own the fund and of course again when
you redeem your shares.
The
other reason that you may not have heard about these offshore funds is
fear. Even though offshore funds cannot solicit US
investors directly, US investors are certainly
permitted to solicit them. Meaning, it is perfectly legal for you
to own shares in any
of the funds offered from Luxembourg,
Isle of Man, Cayman Islands, Honk Kong and elsewhere. However, recent
hassles or
scare tactics regarding tax reporting
issues and money laundering efforts have made many offshore fund companies
refuse
to accept American clients. This
is especially true with the investment companies located in Europe.
Most of these companies
are tired of being harassed by the IRS
or the SEC to cooperate with tax reporting or to turn over investor lists.
If it is not a requirement
in their own country, why should they
do it just because 3% of their clients are American? It is unfortunate,
but this is how the US
government agencies have gotten around
the constitution. It is far easier, and technically legal, to put
the fear of God into a
foreign company, so much so, that they
will not take American clientele. Remember what I mentioned previously.
It is perfectly legal for a US citizen
to own shares in a foreign or offshore mutual fund, annuity or to have
an offshore bank account.
The problem today is finding a company
that is not afraid of the IRS or the SEC and that will take an individual
US citizen as a client.
I do know of a few companies in Europe
that will do it, but they are the exception to the rule.
How Can Investors
participate in an Offshore Mutual Fund?
There
are two problems that both can be addressed by using the Offshore Trust,
Foundation or Company structure.
One problem is something already discussed.
That is the refusal of many offshore fund companies to take US citizens
or residents as clients. While many
firms have a fear about this, for the reasons discussed, they have absolutely
no problem
with a Trust or Non-US company as the
shareholder or beneficial owner of the fund. So, while the US citizen
is shunned, a
Panamanian Corporation or Trust from the
Bahamas is welcome with open arms as a shareholder.
The second problem US investors have is
taxes. Even if you find an offshore mutual fund that will take you
as a client,
and while it is perfectly legal under
US law for you to own such an investment, you still are required to pay
tax to the
US government. This is true regardless
of the fact that there is no tax liability in the jurisdiction where the
fund is domiciled
or if the fund is a SICAV or “roll-up”
type fund that does not make annual distributions. The answer again
is to own such an
investment through a properly arranged
offshore entity.
When
you factor in the tax savings, asset protection benefits and availability
of some excellent investment opportunities;
Offshore Mutual Funds, SICAV Funds, and
Unit Trusts from the Isle of Man or the Channel Islands are extremely appealing
and offer the possibility of returns not
found in the North American market. For additional information
regarding tax-free
offshore mutual funds, please contact
us.
For
Additional Information Regarding Offshore Investments, please send us an
Email.