Eric Flaye, of Conyers, shines a light on the BVI hedge fund structuring options for US sponsors

Many of the initial questions US counsel will have for a sponsor looking to launch a new hedge fund will be about the anticipated investor base, as that factor is fundamental in determining the appropriate fund structure.

The three key categories of investors are: (i) taxable US investors; (ii) tax-exempt US investors; and (iii) non-US investors.

If the anticipated investor base will principally be comprised of taxable US investors, as a general proposition the US sponsor may rely exclusively on domestic jurisdictions (such as Delaware) for all of its potential structuring needs.

However, if the anticipated investor base also includes tax-exempt US investors and/or non-US investors, and such investors represent a material source of prospective subscription capital, the US sponsor may need to include an off shore fund within the broader structure to cater to the particular tax considerations of such investors. This is where the British Virgin Islands (the BVI) – with its unique set of well-regarded, innovative and cost-competitive hedge fund products – comes to the fore.


Taxable US investors: such investors generally prefer to invest in domestic US hedge funds classified as partnerships for US tax purposes (most commonly Delaware limited partnerships or limited liability companies).

Tax-exempt US investors: such investors include certain US pension plans, foundations, endowments and other charitable organisations, and are a material source of hedge fund capital. Passive investment income earned by such investors is generally exempt from US federal income tax; however, this exemption does not extend to ‘unrelated business taxable income’ (UBTI). In the context of hedge funds, the key potential source of UBTI is earnings arising from debt financed investment activities (i.e. trading on margin). If a tax-transparent entity such as a typical domestic hedge fund earns any UBTI, its investors shall be treated as though they earned such UBTI themselves, which may result in US tax liabilities for those otherwise tax-exempt US investors who invest in the domestic fund.

In contrast, off shore entities (such as a typical BVI fund) classified as corporations for US tax purposes can effectively ‘block’ any such attribution of UBTI as they are not tax-transparent vehicles. If the BVI fund earns any UBTI, the character of that income is not passed through or otherwise attributed to its investors. Th is ‘blocking’ effect is the principal reason tax-exempt US investors generally prefer to invest in off shore funds.

Non-US investors: such investors generally prefer to invest in off shore funds classified as corporations for US tax purposes so as to keep out of the US tax net (and avoid any attendant requirement to file US tax returns).

This article was first published in HFM Week How To Start a Hedge Fund in the US 2018.

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