Offshore Hedge Funds moving to Europe

New York ( – In a response issues surrounding the Eurozone as of late, Gregg Davis, CEO of FDi Consulting said “Within the hedge fund space there are concerns of new regulatory shifts that will make the EU a more restrictive location for non EU funds. We agree that there has been and will be in greater scale an exodus from Typical off shore jurisdictions as regards to zero tax locations and the like.”

As financial reform gathers momentum in Europe and the United States, the hedge fund industry is braced for major change, none more important than what appears to be the beginning of a major movement from traditional off-shore tax havens toward domestic domiciles.

Previous pushes for regulatory reform have tended to drive hedge fund off-shore to avoid regulation but interestingly the current effort is having the opposite effect. Even before the push for new regulation, conventional zero tax haven jurisdictions were beginning to fall out of favor as a result of a new financial environment increasingly defined by blacklists, money laundering compliance, and public backlash against high-flying hedge funds. But new legislative initiatives in the United States and the European Union are adding to the momentum. A case in point is the European Union’s proposed Alternative Investment Fund Directive.

The EU-directive is set to place restrictions on the marketing of non-EU funds to European investors ultimately shutting them out from the European market unless they satisfy specific fiscal standards, rules on information exchange between supervisors, and reciprocity as well as anti-money laundering procedures.

As a result, and as per a recent article published in the New York Financial Times entitled “Exit from Caymans to speed up” (May 2, 2010), hedge funds currently located in the Caribbean have started to actively look for alternative onshore locations in Europe.

While the move to set-up funds can be seen as a pre-emptive measure by US managers, it has also given some EU member states the opportunity to make themselves known. Whilst Ireland and Luxembourg are some of the more traditional choices, EU member states like Cyprus have begun to show its potentials as an attractive alternative within the EU market.

“Cyprus already holds the position as one of the most popular holding company jurisdictions in Europe and it has acted as an intermediate jurisdiction for US hedge funds for decades. Ultimately, this development is only natural.” says George Pelaghias with the Cyprus based law firm of Chr. G Pelaghias & Co.

In considering the comparative propositions of these three jurisdictions, the Irish standard corporate tax rate on trading income is 12.5%, and 25% on non-trading income. Dividends paid from Ireland are levied at 20% withholding tax while capital gains are taxed at 25% (in certain cases 12.5%). In Luxembourg the statutory corporate tax rate is 21% and there is a 15% withholding tax on dividends paid to a non-resident company unless the rate is reduced under an applicable tax treaty. Dividends paid by a Family Wealth Management Company, a 1929 holding company or to a qualifying EU parent company are exempt from withholding tax, as are dividends distributed by a Luxembourg subsidiary to its parent if located in a treaty country and provided that conditions similar to the Luxembourg participation exemption regime are satisfied. Capital gains are generally taxed at the standard corporate tax rate; with the exception of gains on movable assets provided that the holding is more than 6 months.

In the case of Cyprus, however, corporate tax is the lowest in the EU levied at a flat 10%. Cyprus also fully exempts profits from trading securities. Furthermore, there is no withholding tax on dividends or interests paid out from Cyprus.

The small table below is not exhaustive, but highlights the main comparative advantages and differences of these three jurisdictions:

Jurisdiction Corporate Tax Dividends Paid Capital Gains Received
Ireland 12,5% / 25% 20% 25% / 12.5%
Luxembourg 21% / 28,59% 0% / 15% 0%
Cyprus 10% 0 0%

The Cyprus regime offers some additional specific benefits to hedge funds. As an example the cost of legal fees for setting up a fund in Luxembourg is generally some €70,000 to €100,000, in Cyprus it is a fraction of that at around €15,000 to €20,000. The Cypriot regime also permits accountants with experience of the process to represent a fund to the regulator rather than requiring direct client presence with the regulator as in Luxembourg. Costs are also likely to be lower in Cyprus. In Luxembourg, for example, there is a 0.01% levy on fund assets under management but no such charge in Cyprus. Fund administration and custodial services are also cheaper than in other Jurisdictions.

“The current discussions in Brussels concerning the Alternative Investment Fund Directive will not only have an effect on the US fund market but will also bring EU states like Cyprus into the spotlight. The Cypriot tax system has recently undergone several amendments in order to strengthen and better facilitate the island’s competitiveness for the hedge fund industry and more changes are expected” stated Cyprus Trade Commissioner in New York, Aristos Constantine.

“Whatever the outcome may be in Brussels with regards to the future of third country fund investments in Europe, Cyprus is undoubtedly on the path of becoming a competitive force to be reckoned with within the European financial service industry.” Constantine said.

By Gregg Davis

Editing by Alex Akesson
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