An offshore standalone structure is one where only one fund vehicle is used and that fund vehicle is offshore (normally in Cayman or the BVI). This structure is mainly used by managers who have no US presence. Normally an offshore standalone structure is solely geared towards non-US investors but it may also be geared towards US based non-taxable investors such as pension funds, charitable organisations and endowments who want to avoid unrelated business taxable income.

A master-feeder structure is normally used where there is a US presence and where a single manager is seeking investment from both US and non-US or tax exempt US investors. The structure will comprise a master fund (an offshore vehicle which is either a limited partnership or a corporate vehicle which elects to be treated as a partnership for US tax purposes), which conducts the trading, and at least two feeder funds which invest all of their assets into the master fund.

One of the feeder funds will typically be a US limited partnership into which the US taxable investors will invest. Using a limited partnership which is a “pass through” entity for US tax purposes means that the allocable master fund’s profits and losses are passed through to investors and taxed at investor level. There is no entity tax at the master fund level in the offshore jurisdiction (either the Cayman Islands or the British Virgin Islands), thus avoiding double taxation.

The second feeder, known as the “offshore feeder”, will normally be an offshore company known as a “blocker corporation”. It is into this offshore feeder that the non-US and US tax exempt investors will invest. Investment into a blocker corporation means that any US tax liability and any requirement to fill in a US tax return arises at the master/feeder fund level and does not affect the investors themselves.

Non-US investors who are not generally required to file US tax returns prefer to invest through this type of blocker corporation to avoid triggering any US tax obligations. If non-US investors invest directly into a fund structured as a partnership they are treated as being engaged in the business of the fund and, to the extent that this includes any US trade or business, will need to file a US tax return and be liable to US taxation. Having a separate feeder fund, which is a corporate blocker, avoids this situation.

For similar reasons, the US tax-exempt investors invest through the offshore feeder. The tax-exempt investors are liable to income tax on any income from trade or business which is regularly carried on and not substantially related to their tax-exempt purpose. This is known as “unrelated business taxable income” (UBTI). If they invest into a fund which is a partnership, they are treated as participating directly in the activities of the fund and some or all of the income derived from those activities will be liable to US tax. The blocker corporation makes use of a loophole in the legislation which, subject to certain exceptions, allows US tax-exempt investors to receive dividends from the blocker corporation without being subject to UBTI.

The master-feeder structure enables the investment manager to operate a single trading entity and avoids the need to allocate trades between separate funds. It also avoids duplication of documentation with counterparties. In some cases, opportunities for leverage may be better than when operating a side-by-side structure.

Similar to a master-feeder structure, a side-by-side structure is used where a single manager is seeking investment from both US investors and non-US or US tax exempt investors who require different tax treatment. Two funds, an offshore and domestic US fund, are established and both are managed in exactly the same way.

This structure is sometimes used for fund of funds strategies but less often for other trading strategies, given the administrative burden associated with either making two identical trades at the same time or splitting trade tickets between the two funds. Unlike the master-feeder structure where there is one performance result, each fund may have slightly different performance results as a consequence of having different fee levels.

The main reason for choosing the side-by-side structure over the master-feeder structure is to enable tax structuring measures to be taken by one or the other of the funds which, if used in the master-feeder structure, would have negative consequences for the other group of investors.

Another option for structuring a fund is to use a segregated portfolio company or “SPC”. An SPC is a company within which separate portfolios have statutory segregation of assets and liabilities. These are popular for umbrella funds operating various classes or portfolios with separate strategies. We will look at SPCs in more detail in a future blog.

If you would like to discuss these options in more detail, please get in touch.

The original author of this post is no longer with Harneys. For more information on this topic, please reach out to the contact listed above.