Transatlantic Structuring
Issues and Trends
Daniel S.Shapiro
&
Richard Thompson
October, 2005
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This information has been prepared by Schulte Roth & Zabel
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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.