There is a broad range of reasons why some AIFs choose to be domiciled offshore, including:

When choosing a domicile for a new AIF or re-domiciliation of an existing fund, typical key elements include the:

In terms of hedge funds, the Cayman Islands are historically popular for US AIF and UK-based managers. Delaware benefits from a similar status for US-based hedge funds. Ireland, the British Virgin Islands and Bermuda are also considered important jurisdictions in this area, but Luxembourg is relatively behind on the hedge fund market.

For private equity and real estate funds, however, Delaware has long been the most important domicile for US managers while the Channel Islands, benefiting from an excellent infrastructure and proximity to the mainland, is a prime location for UK and European managers. Luxembourg is particularly well situated for real estate with a slightly smaller, but still significant, share in the domiciliation of private equity funds. Tax advantages such as the innovation box regime, offering exemptions from tax in relation to IP, have increased Luxembourg's attractions as a location for funds (see box, Innovation box regime: structuring acquired intellectual property).

The importance of offshore centres is not anticipated to change significantly. Offshore centres will continue to play a big role in the AIF industry and fund managers will continue to seek less regulated centres than the EU when establishing a new fund. Nevertheless, pressure on the status quo is increasing as offshore centres have attracted negative attention and new AIF regulation is clearly levelling the playing field for onshore centres. In particular the following key factors have placed increased pressure on offshore centres:

Regulatory impact of the AIFM Directive. The AIFM Directive was published in 2011 and its final implementation by all EU member states is due in the next few months.

The AIFM Directive:

During an initial period from July 2013 until July 2015, only EU-based fund managers will benefit from the European passport. The EU is yet to develop its policy on the managing and marketing of AIFs by non-EU fund managers in the member states (harmonised EU passporting). This is a staged process and the European Securities and Markets Authority (ESMA) is expected to publish its advice on passporting on 22 July 2015. By this time national third country rules will co-exist with the EU rules and apply to non-EU AIFs. The AIFM Directive grants member states until mid-2018 to develop national placement regimes (provided the minimum requirements are met) and private placement regimes will be abolished by 22 July 2018.

Initially offshore funds will not benefit from the EU passport during the transitional period and will continue to depend on national private placement regimes in the EU member states. In addition, offshore funds will need authorisation and be subject to EU regulatory standards if they seek to market the AIF in the EU.

The AIFM Directive stipulates that EU-based AIFs will be regulated by the financial regulator in the home jurisdiction. The AIFM Directive allows non-EU fund managers to market their funds to professional investors under certain conditions in the EU without a licence. Member states can adopt stricter rules in their implementing legislation and some member states are expected to do so which may lead to a significant increase in compliance costs for offshore funds.

Global pressure on tax havens. There have been a variety of national and international initiatives with the aim of putting increasing pressure on tax havens, including:

This pressure has led to offshore centres implementing measures to improve transparency and the exchange of information so that they can, in many cases, be favourably compared to onshore centres.

It is important to note that no offshore centre has yet to be either grey or blacklisted. Nevertheless, increasing amendments to national tax codes have been seen, aimed at limiting the use of tax havens. This has resulted in the creation of more complex schemes for AIFs and investors to benefit from offshore tax advantages. At the same time, new initiatives are showing a political willingness to amend national tax codes to attract onshore AIF's.

In practice the commercial impact of any new regulatory framework will be gradual. There is unlikely to be an overnight transfer of AIFs onshore. Established offshore locations can still offer:

While these will need to be developed in particular directions to comply with the new regulations, it is not anticipated that this will be prohibitively difficult. If best practice norms of transparency, disclosure and compliance are adopted by offshore centres, the case for forcing AIFs away could be considered slightly weakened.

Institutional investors. Decisions on domicile may be determined less by regulatory arbitrage and compliance than on more fundamental principles, such as the business model of the fund and access to investors. The higher regulation that comes with the approval process for an onshore fund will provide a greater degree of security which is likely to encourage business from new and relatively less sophisticated institutional investors. These are likely to prefer a more regulated environment giving access to European legal systems, company law and the regulatory framework. Overregulation can have a strong negative impact on the attractiveness of domicile so it is very important for onshore jurisdictions to find the perfect balance between the protection institutional investors need compared to other retail investors. In addition, insurance companies can face a higher capital charge if they invest in offshore funds and some institutional investors may be prohibited from investing offshore by their bye-laws or other constituting documents.

The large institutional investors that have historically worked offshore will continue to be happy in such jurisdictions as long as the transparency and reliability of the AIFM Directive applies to them. There are therefore no immediate reasons for fund managers to move from an offshore location or establish a new fund onshore to satisfy such investors, as they are perceived to be familiar with offshore domiciled AIFs.

Recent developments demonstrate that institutional investors who prefer an onshore domiciled fund are prepared to accommodate the creation of co-domiciled funds offering a sister onshore fund that mirrors the strategy and investments of the existing offshore fund (such structures are also often put in place for tax purposes).

Although AIFs can take several forms in Luxembourg, the two most widely used regimes are the:

(In addition to the SIF and the SICAR, there is also the Luxemborug holding company (Société de Participations Financières) (SOPARFI), a generic term for a non-regulated investment company holding portfolio investments.)

The SIF, SICAR and SOPARFI do not refer to specific legal forms but to a particular set of legal, regulatory and tax frameworks. This section provides an overview of these forms and the ways in which they can be set up legally.

The Commission for the Supervision of the Financial Sector (CSSF) supervises both institutional and experienced investors.

The SIF is an attractive vehicle due to its flexible functioning rules and extensive investment scope. The laws regulating SIFs do not prescribe any quantitative, qualitative, geographical or other type of investment restriction. SIFs can therefore be applied broadly. It is also possible to create a SIF as an umbrella fund with different compartments each dedicated to a special type of investment policy (for example, private equity, real estate and hedge funds) and strict segregation of assets and liabilities between the compartments. A SIF must not invest more than 30% of its assets or commitments in securities of the same kind by the same issuer (although an exemption could apply for a feeder fund) (CSSF circular 07/309 of 3 August 2007).

The SICAR is specifically aimed at private equity investments and does not require any risk diversification. Risk capital is defined as capital which is high risk (inherent in portfolio investments) where there is an intention to develop such investments.

Fund managers can choose between contractual or different corporate forms.

Both the SIF and SICAR can be established either as a:

The SOPARFI is usually established as either a:

The SIF is characterised by its tax neutrality and is not subject to:

The SIF is subject to a subscription tax of 0.01% which is calculated on the net asset value of its investments (exemptions may apply on certain investments).

The SIF cannot benefit from the application of tax treaties or European Directives which provide reduced withholding tax rates on dividends and interest and exemptions on capital gains on shares. Therefore an intermediate holding vehicle (established as a SOPARFI (see below, SOPARFI)) would be required to make direct investments in portfolio companies. Generally such an intermediate holding vehicle is not required when making investments in funds (for example, a fund of funds).

The SICAR is considered transparent for Luxembourg tax purposes if it formed as a limited partnership (SCS or SCSp). All other SICARs are subject to Luxembourg corporate income tax at the combined effective tax rate of 29.22%. As a taxable entity, the SICAR should therefore be able to benefit from:

This is sometimes challenged by other (treaty) countries on the basis that all income derived from transferable securities (including interest, dividends and capital gains) are fully exempt from tax at the level of the vehicle. Therefore, depending on the geographical focus of the fund, the SICAR may also require a SOPARFI as an intermediate holding vehicle for its portfolio investments (see below, SOPARFI). Distributions made by a SICAR to its investors are not subject to withholding tax.

Foreign investors that hold participation in a SIF and SICAR are not subject to any Luxembourg taxes on gains derived from the disposal of their interest in the vehicle. Both the SIF and SICAR are exempt from net-wealth tax but are subject to either annual or registration fees in Luxembourg.

Management fees paid by the SIF and SICAR to the fund manager or subsequent payments made to local advisors (the effective management team) fall within the scope of the EU exemption on investment advisory services (recently confirmed by a case ruling of the European Court of Justice, GfBk Gesellschaft für Börsenkommunikation mbH v Finanzamt Bayreuth (Case C-275/11) (8 November 2012)) and are not subject to VAT in Luxembourg. Both vehicles are considered VAT persons but perform exempt activities only and are therefore not able to recover VAT incurred on services received from third parties (for example lawyers, notaries and accountants).

A SOPARFI is a fully taxable entity subject to the combined effective tax rate of 29.22% and a 0.5% annual net-worth tax. Generally, the annual burden of the net-worth tax can be effectively reduced to the legal minimum of EUR63 in the case of a SA or EUR25 in the case of a Sàrl.

The SOPARFI is entitled to the benefits of the tax treaties concluded by Luxembourg and the European Directives. The number of tax treaties concluded by Luxembourg has increased and is expected to reach over 65 in the near future. Treaty countries include the UAE, Turkey, Qatar and Hong Kong. However the number of tax treaties are not yet at the level of The Netherlands and there are still no treaties with some southern American countries such as Argentina.

Dividends received from target investments. Dividends received from target investments are exempt from taxes at the level of SOPARFI as a result of the participation exemption regime, provided the SOPARFI either holds or commits to holding in the target, for a 12-month period, either:

The target must be either:

Capital gains on shares realised when exiting a target investment. Capital gains on shares realised by a SOPARFI when exiting a target investment are also exempt from tax under the same conditions applicable to dividends, except that the alternative exemption requirement for a shareholding must be EUR6 million and not EUR1.2 million (see above, Dividends received from target investments). In addition, this requirement must be met on a share-by-share basis, that is, some shares can be sold within the 12-month period as long as an overall shareholding of 10% (or EUR6 million) is held for 12 months.

Advantages of debt financing. Interest income on (mezzanine) debt financing or capital gains on receivables (such as distressed debt investments) are fully subject to Luxembourg tax. In these cases, such tax leakage is significantly mitigated by having the SOPARFI financed with debt. The corresponding interest expenses on such debt could be offset against the taxable interest income leaving only a small taxable profit at the level of the SOPARFI (spread).

Dividends made to a parent company. In respect of a repatriation of gains by the SOPARFI a distinction is made between an equity and debt-funded SOPARFI. Dividends paid by an equity-funded SOPARFI are subject to 15% withholding tax unless a tax treaty or Luxembourg law provides for a lower rate. Luxembourg law provides for full exemption if the parent holds or commits to hold in the SOPARFI for a 12-month period:

Distributions made to a SICAR. In cases where the SICAR is established as a capital company and therefore subject to tax in Luxembourg, distributions by the SOPARFI would be exempt from withholding tax and would also be exempt at SICAR level.

If the SICAR is established as a partnership and therefore transparent for Luxembourg tax purposes, it should be determined at the level of the investors whether this exemption applies.

Therefore, distributions made by SOPARFI to the SICAR can be made free from tax (subsequent payments made by SICAR to its investors are also exempt).

Distributions made to a SIF. Distributions made by a SOPARFI to a SIF with a SICAV or SICAF status are in principle subject to withholding tax at 15% in Luxembourg. Commonly used techniques to eliminate this withholding tax include the issuance of hybrid debt (also known as convertible preferred equity certificates) (CPECs), or alphabetic shares (different classes of shares, such as A and B shares) in combination with a partial liquidation of a specific group of shares (subsequent payments by the SIF to its investors are exempt). These are also frequently used techniques in the event investors in a tax transparent SICAR fail to meet the requirements for the exemption of dividend withholding tax.

In The Netherlands it is easier to benefit from the participation exemption regime and receive an exemption from tax on dividends and capital gains on shares than in the case of Luxembourg (see above, Tax aspects of the AIF structures: SOPARFI). In particular, the participation exemption:

Another benefit of using a Dutch co-operative is that profit distributions are in general not subject to dividend withholding tax. Due to recent legislative changes to the 1965 Dutch Dividend Withholding Tax Act, distributions by a co-operative could become subject to Dutch dividend withholding tax in case of tax avoidance or abusive cases. However, this anti-abuse rule would generally not apply to established AIFs.

The Netherlands has entered into over 90 tax treaties, nearly twice the number as Luxembourg. The Dutch co-operative is increasingly seen as an alternative non-regulated fund vehicle which offers great flexibility for the fund manager and investors due to the constituting documents (for example, the membership agreement) and the absence of rules for capitalisation.

Although the Turkish civil code and tax system have been modernised over the last decade, uncertainty regarding local rules and local authorities remains. In many cases, transparency may be lacking. When investing in Turkey it is important to take into account local corporate income tax and withholding taxes on dividend distributions and interest payments. The rates are currently as follows:

Capital gains realised by a company are generally taxable as ordinary income, however 75% of the capital gains derived from the sale of local participations are exempt under certain conditions (such as a two-year holding period).

Turkey is party to about 75 tax treaties which provide for a reduction of withholding taxes as well as the possible allocation of a capital gain on the disposal of a Turkish target company to the country of residence of the taxpayer. For example, under the treaty between Turkey and The Netherlands, a Dutch holding company receives:

A Dutch co-operative holding Turkish target investments is a very efficient structure due to a combination of factors:

Although The Netherlands has long been seen as the preferred jurisdiction for making investments in Turkey, Luxembourg is gaining ground as the treaty offers similar tax benefits.

However The Netherlands has an advantage over Luxembourg if the investment must also be tax-efficient for Turkish founders in respect of their remaining interest in the Turkish company. The tax treaty eliminates double taxation so that dividends distributed by a Dutch company to a Turkish resident are fully exempt from Turkish taxation. This is in particular useful where the founders/old investors will hold a small participation in the Dutch holding vehicle.