Dwayne Bryan examines how the Bahamas are poised to provide their expert financial services to a wide range of new clients from the emerging markets and exploit the vast untapped potential available.
Investors in emerging markets have specific needs that are driven by a unique set of forces. Local and international regulation, local business practices, sovereign and currency risk and the strength of the underlying economy are all important factors influencing investment flow into an emerging economy. These characteristics make offshore investment strategies an important alternative for the onshore investor, but before we go into the benefits of investing through an offshore environment, we should look at the characteristics an emerging market.
What is an Emerging Market?
In general, an emerging market country is characterised by an underdeveloped or developing commercial and financial infrastructure. These countries have untapped potential for economic growth and allow capital market participation by foreign investors. Countries generally considered as emerging markets often have a debt rating below investment grade, nascent political and economic freedom and a relatively low GNP. The most famous emerging markets are the so-called “BRICS” – Brazil, Russia, India, China and South Africa. While these five countries are well on their way to being recognised as developed markets other countries, including Mexico, Indonesia and Turkey, are often thought to be in the next tier of emerging market economies.
With the onset of the global financial crisis many of the emerging market countries struggled to balance continued growth, currency inflation and debt management. Some previously solid economies are now are quite vulnerable to the global debt contraction and the decline in consumer purchasing power. As investors become more cautious, growth in these markets is expected to slow. Nonetheless, many economic commentators still believe that emerging markets are better poised to achieve long-term growth than their more developed, debt burdened peers. As such, investors need ways to capitalise on the expected growth potential in emerging markets while at the same time limiting their exposure to the complement of risks presented by emerging economies.
Investors in emerging markets have specific needs that are driven by a unique set of forces. Regulation, local business practices, sovereign and currency risk and the underlying economy are all important factors influencing the flow of investment into an emerging economy.
Despite these challenges, funds focused on emerging economies have found offshore structures to be very efficient for servicing emerging market demand. First, offshore vehicles are usually well situated to service the demand for both inward and outward investment. Jurisdictional taxes are minimal and payments made to investors in the offshore vehicle are not generally subject to withholding or distribution taxes in the investment vehicle's home jurisdiction. Other advantages, such as confidentiality, are on the wane, but most offshore jurisdictions still offer some non-tax advantages depending on the jurisdiction and the nature of the transaction.
While both the Cayman Islands and the British Virgin Islands are the two largest offshore domiciles for hedge funds, The Bahamas has continued to raise its profile in this area. Undoubtedly, The Cayman Islands’ performance and name recognition has led it to become the domicile of choice for many emerging market funds. However, The Bahamas now shares many of Cayman's attractions at a better value and without the jurisdictional notoriety.
Key advantages of using a Bahamas domiciled vehicle are:
The pool of lawyers and other service providers, including incorporation and accounting services, is very experienced. In addition there are a number of industry professionals able to act as professional directors of companies, if requested.
Offshore Investment Vehicles: Legal Entities
If you do business outside of your home country, a legal entity should be a requirement, and can sometimes be advantageous for tax purposes. Due to pervasive offshore myths, many people who could benefit from an offshore investment structure are frightened off from offshore companies. However, offshore vehicles are extremely useful for many different applications, including investing.
If you are going to invest offshore, there are a number of ways to go about it, but perhaps the most common method is to establish a foreign trust. A trust can be used for estate planning purposes, protect you from lawsuits, and help pass wealth down through generations. A trust is composed of essentially three parts:
Often there is a fourth element to an effective trust; a protector, who protects the trust by exercising veto power over the trustee. Because trusts are a legal relationship and not a legal entity they are incredibly flexible. The problem with trusts is that although they are useful for passing wealth to the next generation, they are usually tax neutral, with no real tax benefit, to the settlor. A particularly useful feature of a Bahamas trust is that it can be used to hold shares in a private company or to purchase assets. For overseas investments, the Bahamas offers an excellent alternative to the trust in the Exempted Limited Partnership.
Exempted Limited Partnerships
The Exempted Limited Partnership Act, 1995, allows one or more partners, as limited partners, to limit their liability while the other partner or partners have unlimited liability for the debts of the partnership. An Exempted Limited Partnership (ELP) must have at least one general partner who is either resident, or incorporated in The Bahamas and must have the words limited partnership or LP in its name. The registered office of an ELP must be in The Bahamas but it can conduct business anywhere in the world. An ELP is not allowed to conduct business with the Bahamian public except where such business is necessary to carry on business, e.g. office rental, purchasing equipment, utilities etc.
An ELP is exempt from exchange control regulations, and is particularly well suited for mutual funds and or hedge funds investing in emerging markets. As the ELP is exempt from exchange controls, it allows for easy investment in assets denominated in different currencies. ELP’s are also exempt from local tax, business licence fees and stamp duty for fifty years, but they must pay an annual fee.
Offshore Life Assurance / Insurance
One final investment vehicle for investment in emerging markets is offshore life insurance. Offshore life insurance can also be used to provide gains, tax deferment opportunities, and is an excellent investment vehicle. Obviously, the exact structure of this type of arrangement would need to be discussed with your accountants and attorneys but life insurance has been effective in reducing capital gains, and it allows the insured to pass their estate to the heirs with limited tax consequences.
While life insurance pays the beneficiaries of the plan upon the death of the insured, life assurance, allows the insured to be paid a set amount of money for the remainder of their life.
Insurance and assurance provide advantageous investment vehicles through which other investment opportunities can be explored. In other words, an assurance or insurance plan is the vehicle within which other investments, such as bonds, notes, stocks or funds, can rest. Of course, this means that assurance and insurance plans can also be used in conjunction with a trust:
TRUST –contains-> LIFE ASSURANCE –contains–> INVESTMENTS
Through this type of arrangement a client can create a low tax, income producing investment vehicle with positive tax results.
Offshore life insurance gives the investor a chance to select an asset manager, whereas a retail insurance product does not, and it can be used as an investment vehicle whose main goals are income, capital gains and estate tax savings. Proper structure also allows for a high degree of asset protection, while maximising investment choices and incurring as little insurance cost as possible.
Once tailored to a client’s individual situation, offshore life insurance presents an opportunity to minimise taxes, while at the same time capitalizing on investment opportunities.
Implementing an offshore life insurance as an investment vehicle is a sophisticated investment option and there are many traps for the unsuspecting. Some of the tax traps include:
Offshore domiciles have been used not only by global hedge funds, but also by corporations and the wealthy as a way to discreetly invest in higher risk emerging markets. These vehicles allow maximum flexibility while funneling dedicated capital into countries where commercial, legal or business structures may still be in their infancy. Although the global economy has slowed the push for profits in remote and far flung regions is unlikely to change. The Bahamian vehicles described above, as well as others not touched on here, meet the demands of investors the world over: to maximise returns and minimise risk. The Bahamas, as an offshore investment domicile, helps fund managers, investors and institutions to do just that.
Dwayne Bryan, Sand Dollar Group Ltd, Bahamas