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Meet the Offshore Investor Next Door

Therese Raphael writes editorials on European politics and economics for Bloomberg View. She was editorial page editor of the Wall Street Journal Europe.
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The release of the Panama Papers has fed two stereotypes about offshore investing: that it is the exclusive preserve of the rich and that its main purpose is to avoid taxes. Like most stereotypes, it's accurate only in part.

In today's fraught political climate, it's easy to miss the fact that investment funds listed outside the U.K. (and U.S.) help plenty of middle class people too. That isn't the image that immediately springs to mind these days or which has motivated calls for a regulatory crackdown on offshore investments. But ordinary employees of Britain's largest companies, trade unions and councils also participate in offshore investing, through their pension plans. 

These investments are part of the second-largest investment industry in the world, after the U.S.'s, with 5.5 trillion pounds ($7.8 trillion) under management at the end of 2014. Some 895 billion pounds of those assets are managed in funds that are domiciled offshore, a figure that grew by 16 percent between 2013 and 2014.

That isn't all casino money for hedge-fund speculators. Over a third of the U.K.'s local-government pension plans allocate money to hedge funds, which are largely based offshore. According to the Alternative Investment Management Association, they generally allocate around 7 percent of their total investment portfolio to such funds.

The same goes for the private sector, where 64 percent of the top 25 U.K. corporate pension plans invest in hedge funds. Defined-benefit pension funds -- which comprise most pension plans and held over 1 trillion in assets in 2013 -- invest around 60 billion of their assets in hedge funds.

All offshore funds are supposed to be "tax neutral" in that the fund itself isn't taxed but investors must pay tax in their own jurisdictions on income and capital gains. That's not unique to island domiciles; much of the offshore allocations end up in Ireland, Luxembourg or the U.S. The Cayman Islands represent over a quarter of hedge fund domiciles. A low- or zero-tax rate on some investment funds exists in many jurisdictions (the U.K. exempts various investment companies and trusts from taxes on capital gains, for example). What defines a haven for tax-dodging is its refusal to cooperate with tax authorities to counter tax-evasion attempts.

That's becoming less common. In 2000, the OECD took the Cayman Islands off its "tax haven" blacklist after the Caymans complied with higher standards of transparency. In 2009, it removed holdouts Andorra, Liechtenstein and Monaco from its list of uncooperative jurisdictions. Panama was removed in 2012, perhaps prematurely.

For the non-criminally inclined, the attraction of, say, the Cayman Islands has little to do with taxes and more to do with the benefits of lighter regulation -- such as how much leverage a fund can have, or the ability to short-sell. Funds located offshore can offer more flexibility than is available to onshore managers in London, in part because the relevant laws in Britain long predate the hedge fund industry's existence. It's doubtful regulators have the appetite -- and certainly they lack the resources -- to regulate that industry onshore.

While the tax break for funds may seem generous, it's worth bearing in mind that adding another layer of tax at the fund level would probably mean higher charges passed along to investors, with any tax benefit going to the offshore jurisdiction rather than brought home. It would not only dent the wealth of those who are able to afford more exotic investment options, it might also harm ordinary investors in employer pension plans -- a major part of one of Britain's strongest industries. With a whiff of British class war in the air, that common interest has been overlooked. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Therese Raphael at traphael4@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net