For many years, the US investment vehicle landscape has had a strong affinity to Cayman domiciled structures. Immense benefits can be achieved for US tax-exempt investors as well as non-US investors in US structures through the use of offshore, Cayman Islands domiciled feeder funds. However, in setting up these structures, withholding tax (and the ability to reclaim taxes incurred on foreign investment income) is often overlooked.
As is common for most tax havens, the Cayman Islands doesn’t have a network of double taxation agreements which can be utilized to minimize taxes incurred on foreign dividend and interest earnings.
Traditionally, many Cayman-domiciled feeder funds were established as Cayman limited companies. These Ltd. entities were non-transparent in nature (unless they ‘checked the box’ to be treated as US partnerships) and because of the lack of a tax treaty network between the Cayman Islands and common investment jurisdictions, investors have had to swallow the pill of foreign withholding taxes without any option of recovery. The only alternative to this was to structure the Cayman-domiciled feeder fund as a Limited Partnership (LP) as opposed to a limited company. The LPs are seen as transparent entities for tax purposes and therefore enable a “look-through” of the LP, to the underlying investors. As a result, the underlying investor is viewed as the beneficial owner which will allow him to recover the proportionate withholding taxes based on the tax treaties which exist between the investor’s country of residence (generally the US) and the country of investment.
In July 2016, a new investment vehicle was launched in the Cayman Islands – a Limited Liability Company (LLC), very similar to the LLCs which exist in Delaware in the US. This Cayman domiciled LLC provides the necessary controls and oversight which come with a corporation, however for tax purposes these entities provide the ability to “look through” the LLC to underlying investors. The LLC structure retains the legal personality required to ensure that there are no unwanted US tax consequences for US investors by essentially “blocking” the identity of investors. At the same time, this structure provides investors with the opportunity to reclaim withholding taxes from many foreign jurisdictions in line with their proportionate share of ownership in the relevant LLC because of the tax transparent nature of the structure.
The benefits of this “look through” principle for LLCs can be far reaching as US tax exempt investors are unable to apply foreign tax credits to offset any of the costs incurred through foreign withholding taxes. Their only option to recover foreign withholding taxes is by filing foreign refund claims which is made possible when investing through the LLC structure as opposed to the Ltd. Structure.
Furthermore, tax exempt investors can often make use of exemptions from withholding tax which allow them to recover the full amounts of foreign tax suffered.
WTax has seen many clients convert from the traditional Ltd. structure to the LLC structure to yield many benefits, one of which being additional withholding tax recovery opportunities.
In conclusion, the Cayman LLC structure provides opportunities for withholding tax recovery which previously did not exist. Converting to an LLC structure or choosing this vehicle when establishing new funds should be explored.
WTax is a division of the VAT IT Group, a multinational indirect tax services provider. WTax helps investment companies across 107 jurisdictions globally through our over 45 offices worldwide. WTax has successfully recovered withholding tax for over 75 different legal structures and helps over 4,000 funds to recoup their withholding tax.
If you wish to explore your refund opportunities related to Cayman Islands domiciled structures, contact one of our consultants.
* Note: This article is written on the premise that the Master Fund in the Master-Feeder structure is a transparent entity.