In this guest post, Brian Sapadin, Executive Director of GlobeTax, discusses the benefits of tax reclamation and the opportunities presented by the new Cayman LLC draft legislation.
With the highly anticipated Cayman LLC law finally being published in draft, once unobtainable foreign tax reclaim entitlements are expected shortly to be in play for eligible investors whose Cayman fund undertakes a conversion to the new structure (or, in the case of a new launch, initially structures as a Cayman LLC). Most U.S. tax-exempts invest through offshore feeders, traditionally a Cayman limited company (Cayman LTD), to avoid Unrelated Business Income Tax (UBIT) which can be assessed to U.S. resident tax-exempt investors for gains made on leverage, including traditional margin or shorting strategies. Unfortunately, investors in such vehicles do not have access to double taxation treaty benefits, since the Cayman vehicle serves as a corporate blocker and Cayman itself is not party to bilateral tax treaties.
In a Cayman LLC — a transparent “look-through” vehicle — U.S. tax-exempts (and the fund manager) should soon be able to reap the benefits of tax treaties, for eligible markets other than the U.S., while still being shielded from UBIT.
Since there is no tax credit for tax-exempts to utilize, any recovery is pure alpha for the fund. Further, in a number of markets, tax-exempts are entitled to recover the entire withholding attributable to their level of participation in the fund.
Similarly, foreign investors whose domiciles allow for treaty benefits would also have opportunities to lodge claims. One caveat to note is that the fund manager would need to initiate the process to lodge claims on behalf of any underlying investors.
With over $1 trillion in hedge fund assets domiciled in the Cayman Islands, the ability to access treaty benefits, particularly for U.S. tax-exempts, could have a meaningful impact on fund performance. If there is wide scale adoption of the new Cayman LLC structure, we estimate that over $1 billion in annual entitlements could be unlocked and recovered.
We encourage all offshore investors to discuss the potential benefits of conversion with their fund managers. ERISA funds, in particular, are under increasing scrutiny from the U.S. Department of Labor to act as a fiduciary and recover all available entitlements. While GlobeTax has focused on the benefits relating to tax reclamation, there are additional benefits to structuring as an LLC. Fund managers should discuss with their legal counsel, and closely weigh the benefits of a pro-active conversion and/or launch once Cayman LLCs are available.