Destination unknown

It is becoming increasingly common for wealthy families to use private fund structures as asset-holding vehicles. At the same time, the use of family office and multi-family office investment advisory entities also seems to be spreading. As a result, we are seeing some degree of convergence between the world of the private client adviser and that of the fund manager.

However, engaging with the world of fund management requires advisers to acquaint themselves with a range of fund structures, regulatory terms and concepts, and investment market terminology and jargon, much of which may not necessarily be familiar to them.

Direct approach

As a first step, it is always useful to consider the main factors that tend to dictate the choice of both the structure and the jurisdiction for an investment fund. Broadly, those are:

• Tax. The first principle here is that no fund structure should leave the investor materially worse off than a direct investment in the relevant assets. Tax concerns break down into sub-categories: (i) tax (or, ideally, the absence thereof) on the fund structure; (ii) the tax impact on the investors, having regard to their tax profile(s) (again, the investor shouldn’t end up worse off – for instance, a fund structure that succeeds in converting a capital gains taxable receipt into one taxable at income rates is less than ideal); and (iii) tax at the level of the investment, e.g. withholding taxes (and, if possible, their mitigation through the structure).

• Regulation. Again, this has separate limbs to it, i.e. regulation of the fund structure itself, and regulation of those service providers involved in either managing or advising that structure or promoting it to the investor. For the private client adviser, the ideal scenario therefore is a structure which (i) does not require an excessive degree of regulatory clearance and oversight; (ii) is compatible with the family’s investment strategy (no point, for instance, in suggesting a UCITS structure for a portfolio of artworks); and (iii) is compatible with the regulatory status, or lack thereof, of any family-owned entities who are actors in the structure, e.g. as managers or advisers.

• Commercial convenience: this is something of a “sweeper” category and covers (i) the need for the structure to be consistent with commercial objectives and the nature of the underlying assets (highly liquid open-ended investment companies for instance, don’t mix well with highly illiquid private equity or property investments); and (ii) jurisdictional / geographical factors, e.g. time-zone convenience, proximity to existing service provider relationships and the availability of the “right” structures and / or service providers for any given fund or strategy in a particular jurisdiction.

The times being what they are, the above considerations may now also need to be considered through the somewhat distorting prism of the AIFM directive, which may in some cases affect either the structure used or the jurisdiction of choice.

To illustrate how the various factors outlined above actually operate and interplay in practice, let’s take three fictitious examples and suggest some possible family investment structures for consideration.

Family A. This is a wealthy UK resident and domiciled family, who recently sold a family business for £200m. The head of the family is particularly interested in succession planning. As regards investment objectives, the family’s FSA-authorised investment advisers are suggesting the family’s wealth be divided into three ‘pots’: one dedicated to conventional long-only strategies; one to ‘alternative’ investment funds; and one to real property.

Family B. This is an internationally dispersed family, with no UK or other EU links but with certain members now resident in the US and subject to US taxation. The family’s investment strategies cover a wide range from long-only to alternatives. One family member, a New York trained investment banker now resident in Switzerland, wants to establish an advisory entity there to assist in advising the fund structure.

Family C. This is a family whose members are resident in various continental European jurisdictions, whose investment aims are much the same as those of Family B and who have an existing family office advisory entity based in Monaco.

Selection policy

Taking Family A first, given the family’s UK tax residence, a useful vehicle for the long-only ‘pot’ would be a UK FSA-authorised private OEIC. These structures benefit from an exemption from UK corporation tax on capital gains, and being onshore are not subject to the ‘offshore funds’ regime, which can impose adverse tax consequences on UK investors in certain offshore investment structures (essentially those - such as investment companies and unit trusts – which are not treated as tax transparent by HMRC).

From a regulatory perspective, a UK OEIC would clearly need to be operated and investment-managed by FSA-authorised service providers. The family’s investment advisers would probably be able to perform the investment management role, depending on their regulatory permissions. However, it is likely that separate specialist service providers would be required for the fund ‘operating’ and ‘depositary’ roles, though such service providers are not hard to find.
How to deal with the other two pots though? One approach might be to impose a family limited partnership structure at the top level, with classes of limited partnership interest dedicated to each of the three pots. Family limited partnerships (FLPs) are increasingly commonly used in UK tax planning as an alternative to trusts, especially since the tax treatment of trusts in the UK somewhat hardened following the Finance Act 2006.

For regulatory purposes, FLPs are collective investment schemes and generally therefore need an authorised operator (if established in the UK) and investment manager. Normally, however, a family-owned general partner can be established, which delegates the activities comprised in operating the FLP to an authorised person (although certain very high-level strategic activities may be capable of being retained by the family without compromising the regulatory analysis).

Similar regulatory considerations may apply offshore the UK, under the applicable local laws. It is often convenient to use an offshore limited partnership structure instead of a UK one, as the offshore jurisdictions tend to have more modern and flexible limited partnership statutes. They also generally have ‘private fund’ structures for regulatory purposes, which enable funds with small numbers of investors (limited to 15 in Jersey, or 50 in the British Virgin Islands or Isle of Man) to be established without regulatory authorisation (though any promotion of the FLP or associated investment services to Family A would of course need to be carried out within the parameters of the UK regulatory regime).

As regards Family A’s ‘alternatives’ pot, it is very likely that any hedge funds invested in, and indeed other alternative funds structured as opaque entities for UK tax purposes, would be caught by the offshore funds regime and may therefore need to be held through insurance wrappers to be tax effective.

It remains to be seen whether the EU’s Alternative Investment Fund Managers Directive, which came into force recently and must be implemented in member states by July 2013, leads to a drift in fund establishments from non-EU to EU financial centres. The finer print of the implementing legislation has yet to be produced, and we do not yet know how easy it is going to be, in practice, for non-EU financial centres to negotiate cooperation agreements with EU jurisdictions, so as to facilitate continued use of those jurisdictions for fund structures aimed at EU residents. However, Ireland and Malta both have limited partnership structures which work along similar lines to the UK and could therefore in principle be used if an EU FLP structure (outside the UK) is required.

Ring fencing

Turning now to Family B, given the residence of the family members it appears we have the luxury of being able to ignore both UK tax and regulatory considerations and the AIFM implications. A likely structure here may be a Cayman or BVI or segregated portfolio fund or Jersey/Guernsey protected cell company (PCC) fund, where separate ring-fenced portfolios within the same fund can be established for the different investment strategies.
If capable of being set up as a private fund, there should be no issue in enabling the Swiss advisory entity (subject to any local Swiss tax and regulatory issues) to provide investment advice to the fund. For sound governance reasons, of course, the family will likely want to see well-reputed service providers in the structure, in particular as custodians, fund administrators, and perhaps also fund investment managers (with power to take advice from the Swiss entity).
The main tax and regulatory issues of focus here however, given the US links of certain of the family members, would likely be US ones. It would be essential at an early stage to take US tax and securities advice, to ensure that the offshore fund did not constitute a passive foreign investment company (PFIC) for US tax purposes (which would have adverse tax consequences for the US family members) and that the Swiss adviser did not fall foul of the Dodd-Frank legislation and require SEC registration.

However, one issue that might predispose Family B to the use of an onshore/offshore EU-based vehicle may be if any chosen asset class, or jurisdiction of investment, is subject to significant withholding taxes, or (indeed) if any family members are affected by local tax “blacklisting” laws in their jurisdiction(s) of residence. The use of an Irish, Luxembourg or Maltese fund vehicle may assist in overcoming these issues, perhaps however at the cost of using a locally regulated investment manager entity. In assessing whether tax treaties may be useful in mitigating withholdings however, it is always crucial to have regard to the limitation of benefit provisions in the relevant treaty or treaties, many of which can be highly restrictive.

Family C’s requirements, structurally, resemble Family B’s, but without the US complications. However, given the continental European flavour of this particular family, it is likely that, both for (prospective) AIFM reasons and (perhaps) tax reasons in the jurisdictions of individual family members, an EU structure would be favoured rather than a Caribbean or Channel Islands one. Good alternatives present themselves in the form of Luxembourg Specialist Investor Funds (SIFs), Irish Qualifying Investor Funds (QIFs) and Maltese Professional Investor Funds (PIFs). All these jurisdictions allow for fund structures of the PCC/segregated portfolio variety. The trick here will be to find a locally authorised investment manager in the chosen jurisdiction, who is happy to take contractual and regulatory responsibility for the management of the fund while being at the same time willing to take advice from the Monaco family office.
The above is, of course, something of a whistle-stop tour through the offshore and onshore worlds. Hopefully, however, it will serve as a very general route map to the available alternatives.

John Langan is a partner at Maitland Advisory LLP