transatlantic structuring issues and trends daniel s.shapiro & richard thompson october, 2005
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Transatlantic Structuring Issues and Trends
Daniel S.Shapiro&
Richard Thompson October, 2005
DisclaimerThis information has been prepared by Schulte Roth & Zabel LLP ("SRZ") for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty whatsoever as to the accuracy or completeness of the information or whether it reflects the most current legal developments. Distribution of this information is not intended to create, and its receipt does not constitute, an attorney-client relationship between SRZ and you or anyone else. Electronic mail or other communications to SRZ (or any of its attorneys, staff, employees, agents or representatives) resulting from your receipt of this information cannot be guaranteed to be confidential and will not, and should not be construed to, create an attorney-client relationship between SRZ and you or anyone else. No one should, or is entitled to, rely in any manner on any of this information. Parties seeking advice should consult with legal counsel familiar with their particular circumstances. Under the rules or regulations of some jurisdictions this material may constitute advertising.
The Transatlantic Trends US Hedge Fund Managers open
offices in London Early 1990s – Largest Fund
Managers (“Global Macro”) Mid 1990s
Merger Arbitrage Funds Long/Short Equity Funds Multi-Strategy Funds
The Transatlantic Trends Recent London Office Openings
Emerging Markets Fixed Income Funds – Distressed Debt,
Convertible Arbitrage Commodities Funds – European Based
Trading Fund of Funds
The Transatlantic Trends Simultaneous openings in US and
London “Reverse Openings”
London-based Managers opening offices in US
“Spin-offs” from London offices of Institutions (investment banks; banks) and Hedge Funds
US Firm Establishing a UK office Types of UK Offices
Research only Marketing Full Trading
Number of Considerations
Tax and Regulatory Issues
UK Office
Separate Legal Entity to avoid tax/regulatory issues for US Management Entity
Choice of entity – typically corporate vs. LLP
Choice of Entity UK Limited Company – well understood;
limited liability for shareholders; simple to establish
UK LLP – limited liability partnership; hybrid: transparent for tax purposes and treated as corporate for other purposes; generally limited liability for members; tax advantages, include ability to admit new members into LLP and make changes in their interest without “compensation” tax risks; flexible – terms can be set out in the LLP Agreement
LLP may not be suitable where US Firm is a large corporate institution
LLP Tax Advantages
Corporate employer pays 12.8% National Insurance (“NI”) in respect of its employees’ salaries
LLP does not pay NI in respect of its members’ profit allocations
LLP members or employees subject to same NI rates
LLP Structure
LLP members usually include the key UK individuals as well as UK limited company as a corporate member
Corporate member typically wholly owned by US management entity
Corporate member and LLP “check the box” to be treated as transparent for US tax purposes.
Corporate Member Corporate Member typically has majority of
voting rights in LLP Corporate Member will also make decisions
on certain key matters, e.g. appointment and removal of members
Allocations of LLP income often decided by Corporate Member subject to contractual provisions
Income allocated to Corporate Member can be dividended to US parent (30% UK tax credited against US tax liability of individual owners of US parent company)
LLP Members
LLP members should not be disguised employees for UK tax purposes
Members should be appropriately senior individuals, with some capital at risk in the business and some voting rights
Fees
UK tax rules (the “Investment Manager Exemption”) require the “customary” rate of remuneration to be paid to the UK entity for the services it provides
Need for Transfer Pricing Study must be considered
Regulatory Issues
Certain activities conducted from the UK require FSA permission
Investment management, investment advisory and fund marketing all mean the UK entity should be FSA registered unless an available exemption applies, for example, investment research and advice provided to the US parent under the available “group exemption”
FSA Registration Process Substantial application pack to
complete Details of structure; ownership;
personnel and projected finances
Controllers
Persons with 10% or more of the capital or voting rights of the UK entity to register with FSA as controllers
Ultimate controllers to be disclosed Due diligence type information to be
provided Individuals with a 30% or greater interest
to provide statement of net worth
Approved Persons
CEO and Compliance Officer of UK entity to be UK based – FSA want to see “mind and management” of the UK entity in the UK
Investment Managers to demonstrate “competence” – may require exam passes/waiver applications
FSA generally require 2 investment managers – if only one then establish procedure if that individual is incapacitated
No Conditional Approval
Regulated activities may not be conducted prior to obtaining FSA authorisation
Note: conducting regulated activities without FSA authorisation is a criminal offence
US Firm with Existing UK office Many US firms initially established UK
offices as corporations Tax efficiencies have prompted many of
them to convert those UK corporations to LLPs
Converting to new legal entity means new FSA registration required
Expedited FSA application process exists for a simple change of entity
US Firm with Existing UK office On receipt of FSA approval novate
investment management agreements to new LLP and contribute existing business to LLP
To avoid CGT on disposal, existing entity contributes business at agreed value and retains right to allocation of same value on sale/winding up
Structure of US Manager Entity Structure of separate US Management
Company – simplest structure is to use a corporation. However, this is tax disadvantageous because corporation taxes (Federal, New York State and New York City) on profits would be at an effective tax rate of about 46%. If US corporation owned by UK LLP or its members, no tax credit on UK tax return would be available for US taxes paid.
Preferred Tax Structure
US Limited Partnership with principals of UK manager serving as LPs. Effective US tax rate in profits, if office in NY, is 42%
Major issue is – will individual members of UK management entity be willing to file US tax returns, even if only their income “effectively connected” with the business of the US manager will be reported?
Alternative Structure - Use of UK LLP Alternative to avoid US tax filings by UK
individuals – Formation of UK LLP to be LP of US Partnership UK LLP (treated as a corporation for US tax
purposes) files US Federal and NY State and City tax returns
Higher net tax rate (46%), but UK individual partners not required to file US returns. However, because UK LLP is transparent for UK tax purposes, individual UK LLP members will get a UK tax credit for US taxes paid by UK LLP
Use of UK LLP
Repatriation of US Partnership Income
US withholding tax of 5% can be avoided if at least 95% of voting and value of UK LLP owned directly or indirectly by 7 or fewer individuals
Deferred Fee Plan for Partners If UK LLP used, US Manager cannot have an
effective fee deferral arrangement with offshore fund because any partnership having a corporate partner must report its income on accrual method, not the cash method. If US partnership has only individual Limited Partners and no UK LLP partner – US Manager can implement with offshore fund effective deferred fee Agreement for UK principals who are partners and, perhaps more importantly, US traders who expect to be able to defer some portion of their share of incentive fees payable to US Manager by offshore fund.
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