A wealth of opportunities: Cayman investment funds and Latin American HNI’s

Read our article in the Cayman Financial Review Magazine, eversion 

With a record number of billionaires hailing
from Latin America this year1, predictions are that the region will
only get wealthier and Brazil is leading the way2. As a result of higher commodity prices and a
stronger currency, the number of billionaires in Brazil increased by 60 per
cent between 2009 and 2010. Brazil is now estimated to have the 10th largest
population of high net worth individuals (HNIs) in the world3. With
increased wealth, Latin American HNIs are motivated to search for optimal
vehicles and domiciles to diversify, protect and enhance their holdings.  

Traditionally, Latin American
HNIs have favoured using offshore holding companies to facilitate investments
overseas and many have invested in offshore funds. However, following the
global economic crisis, Latin American HNIs have demanded greater transparency
and control over their investments and as a result, requests to establish
family funds have been on the rise. By establishing family funds, Latin
American HNIs may consolidate their investments into a formal structure which
is flexible, transparent and allows for control over strategy, operation and
risk. Family funds may also be tailored to suit specific needs. For example,
funds structured as segregated portfolio companies, allow individual family
members to have separate segregated portfolios, managers and custodians within
a single vehicle.  

Why
Cayman funds are appealing
 

Latin
American HNIs find Cayman an attractive domicile for family funds for the same
reasons Cayman is regarded as the leading investment funds jurisdiction. Cayman
is a sophisticated, stable and tax neutral jurisdiction, famous for responding
rapidly to market requirements, as well as economic and regulatory
developments. Cayman offers quality service providers, is well regulated and
boasts a Commercial Court served by specialist judges who are qualified to
resolve complex commercial disputes. Additionally, Cayman’s common law legal
system provides comfort, certainty and protection for investors.   

Aside
from these well known features of Cayman as a domicile, Latin American HNIs
find Cayman funds appealing for other reasons, mostly relating to local
conditions in Latin America. 

Cayman’s welcoming environment  

Business goes where
it is invited and Cayman is welcoming Latin American HNIs to its shores. In
Cayman, there is clear recognition of the importance of Latin America to the
world economy and of the significant opportunities for economic cooperation
that exist. In 2008, Cayman industry leaders visited Brazil to increase
awareness of Cayman offshore services. Since then, the relationship between
Cayman and the region has deepened, with the Cayman Islands Monetary Authority
concluding formal arrangements with the Brazilian Securities and Exchange
Commission (CVM) and the Mexican Banking and Securities Commission.  

Cayman’s service
providers have adapted to cater to Latin American clients. Many employ
professionals who are fluent Portuguese and Spanish speakers, have cultural
experience of Latin America and are able to provide the personal service which
the region’s HNIs require. 

Though
large Brazilian institutions have had a presence in Cayman for some time (Banco
do Brasil, Bradesco, Itaú), the recent acquisition of a Cayman bank by
Brazilian family conglomerate Cohab/Aboulafia demonstrates that efforts to
increase economic cooperation have been successful. Cohab gave as reasons for
its attraction to Cayman, its political stability and the quality of its
regulatory regime and service providers.  

Availability of registered structures  

Latin American HNIs
appreciate investment funds which may be registered by a recognised regulatory
body. Cayman funds can be registered with CIMA and though family funds often
qualify for exemption from registration under applicable law4, many
Latin American HNIs opt for registration5 as this gives substance to the structures in
dealings with counterparties and domestic authorities. In Brazil for example,
the bona fides of unregistered funds is sometimes questioned by the tax
authority when assessing payments received by Brazilian investors.  

  Tax mitigation  

HNIs
find Cayman funds appealing from a tax perspective, when compared to offshore
holding companies, either for overseas investment or for re-investment in
Brazil. Investment through a Cayman fund may result in a reduction in the
amount of Brazilian tax paid on earnings from these investments. Redemptions of
equity interests in a Cayman fund are subject to 15 per cent tax in Brazil on
the capital gain. Payment of tax is deferred until redemption. By contrast,
where investments are made through overseas holding companies, dividend
payments are subject to tax in Brazil at the higher rate of 27.5 per cent and
any gains on realisation of the investment are also subject to 15 per cent
capital gains tax. 

Protection of assets 

HNIs
in many Latin American countries fear state powers which may be exercised over
private property. Such powers range from the forced nationalisation of private
property in Venezuela to the authority of the Central Bank in Brazil to freeze
assets of individuals who are directors of, or connected to, insolvent
companies. One way in which investors may guard against such appropriation is
by placing assets in a Cayman fund. 

Currency protection  

Investments
made through a Cayman fund may serve to shelter private wealth from local
market and currency fluctuations. These fluctuations are common and frequently
occur around the time of elections. Notably, on 6 June 2011, the Peruvian stock
exchange suffered a record fall following the presidential run-off election.  

Succession planning 

Cayman
funds are also an attractive option for succession planning. Forced heirship
rules, applicable in the South American Latin countries, but not Mexico or
Central America, limit discretion to dispose of assets on death. These rules
allocate a proportion of the deceased’s estate to certain heirs in preference
to others. In Cayman, there is testamentary freedom and investments in Cayman
funds, which are disposed of by a valid Cayman will, may be preserved from the
effects of forced heirship.  

Comparison of Cayman and Brazilian investment funds 

An examination of some
differences in the features of Cayman funds and Brazilian domestic funds will
further highlight the attractiveness of Cayman funds for Latin American HNIs.  

(i)  Permitted
activities
 
 

Investment
funds in Brazil are highly regulated and consequently, Brazilian funds may lack
the flexibility that HNIs desire. Fund strategy, asset type and diversity are
limited by the category of fund established. There are specific rules attaching
to each category and only certain funds may invest overseas. Additionally, with
the exception of private equity funds, Brazilian funds are not permitted to
take loans. Cayman funds have far more flexibility. There are no legal
restrictions on the asset type, asset concentration, strategy or overseas
jurisdictions in which a fund may invest. There are also no legal restrictions
on borrowing. 

(ii)     Structure
 
 

Brazilian
domiciled investment funds take the form of a condominium with assets jointly
owned by investors. Investors are jointly liable for the liabilities of the
fund and such liability is unlimited. An investment in a Cayman fund offers
more protection in this regard. Cayman funds may be structured as companies
(exempted, segregated portfolio or exempted limited duration), partnerships or
trusts. Companies have separate legal personality and hold assets separately
from their investors. Assets of exempted limited partnerships and unit trusts
are held separately from investors by the general partner and trustee
respectively. In addition, investors in Cayman funds established as exempted
limited liability companies and exempted limited partnerships enjoy limited
liability.  

(iii)    Confidentiality
 
 

With
numerous instances of kidnapping and theft in Brazil, for HNIs, it is important
that details of their personal wealth remain private. However, domestic
products may not provide the desired level of privacy. Brazilian funds must
report their positions to the CVM and these are publicly accessible. Other
details such as the names of operators are also published by the CVM and enquiry
may often reveal to whom fund investments are attributable. Investment in
Cayman funds provides greater comfort in this regard. Information reported to
CIMA by registered funds (such as names of directors) is not made public and
financial reporting is limited to annual audited financial statements which are
also kept confidential.  

(iv)     Tax
rate on profits
 
 

Generally6, an investment in a Brazilian fund, where the majority of assets held
are not listed securities, will result in withholding tax on the capital gain
made by the investor which is collected: 

  • at the end of May and November each year at the rate of 15 per
    cent (or 20 per cent for short term investments) over the life of the
    investment under the “come-quotas”/”share-eating” regime;
    and 
  • on redemption, at decreasing rates from 22.5 per cent to 15 per
    cent, depending on the maturity period. 

By contrast, there are no direct taxes in Cayman. Even though Brazilians
are taxed on their worldwide income, where correctly structured, a Brazilian
resident would only be liable for Brazilian tax on capital gains made in a
Cayman fund at the rate of 15 per cent. 

Latin American HNIs
have been drawn to establish Cayman funds by Cayman’s welcoming environment,
sound regulation and quality infrastructure. The robust growth experienced in
Latin America and specific local conditions have also opened doors for Latin
American HNIs to benefit from using Cayman funds. As Latin America’s rise
continues, Cayman is well placed to facilitate the region’s journey, by providing
innovative fund products tailored to suit the needs of HNIs. It is anticipated
that there will be increased use of Cayman funds by Latin American HNIs as
complementary and alternative investment options. 

 

Endnotes 

  1. Forbes Magazine Rich List 2011.
  2. Financial Times, “BRICs becoming billionaire factory”, 9 March 2011.
  3. 2010 Capgemnini World Wealth Report
  4. Mutual Funds Law (2009 Revision) of the Cayman Islands (the “Mutual Funds Law”)
  5. Registration is only available to investment funds which fall within the definition of mutual fund under the Mutual Funds Law.
  6. A detailed analysis of the tax regime in Brazil for fund investors is beyond the scope of this article.
Cayman investment funds and Latin American HNIs
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Janet Francis

Janet specialises in Corporate Law with focus on investment funds. She has considerable experience advising investment managers, institutional and private investors, and service providers on the establishment, re-structuring and on-going operation of Cayman Islands alternative investment funds.

Janet Francis
Partner
Smeets Law (Cayman)
Suite 2206, Cassia Court
72 Market Street, Camana Bay
PO Box 32302
Grand Cayman, KY1-1209
Cayman Islands

T: +1 (345) 815 2800
E: jfrancis@smeetslawnet.com
W: www.smeetslawnet.com 

Graeme Jenkins

Graeme’s practice is concentrated on corporate law with a focus on investment funds and Latin America. Graeme previously practised at private equity specialist, Dickson Minto WS and at Herbert Smith LLP in London, advising on international transactions. Graeme is fluent in Portuguese, Spanish and French.

Graeme J. Jenkins
Senior Associate
Smeets Law (Cayman)
Suite 2206, Cassia Court
72 Market Street
Camana Bay
PO Box 32302
Grand Cayman, KY1-1209
Cayman Islands

T: +1 (345) 815 2800
E: gjenkins@smeetslawnet.com
W: www.smeetslawnet.com