Pwc Reg Distrib Hedge Funds05

8/14/2019 Pwc Reg Distrib Hedge Funds05

1/40

The regulation and distributionof hedge funds in EuropeChanges and challenges

June 2005


2/40

Section 0

1 Foreword

2 Section 1: Current developments in the hedge fund market

4 Section 2: Pan-European regulatory developments

9 Section 3: Current developments in the taxation of hedge funds,hedge fund managers and hedge fund investors

12 Section 4: Country by country overview: Regulation of hedge funds andtaxation of hedge fund investors at May 2005

29 Table 1: The availability of hedge funds and funds-of-hedge funds toinvestors by country at May 2005

31 Table 2: Channels for distribution of hedge funds by country at May 2005

34 Table 3: Regulation of hedge fund managers by country at May 2005

36 Table 4: Taxation of hedge funds and hedge fund managers by countryat May 2005

PricewaterhouseCoopers Global Alternative Investment ManagementIndustry Group Contacts

2 PricewaterhouseCoopers The regulation and distribution of hedge funds in Europe Changes and challenges June 2005

The regulation and distribution ofhedge funds in Europe

Changes and challenges

Contents


3/40

1PricewaterhouseCoopers The regulation and distribution of hedge funds in Europe Changes and challenges June 2005

The European hedge fund industrycontinued its rapid growth last year.This was driven by increased demandfrom institutional investors together with

changes made by some nationalregulators and fiscal authorities, tofacilitate greater access to hedge fundproducts. In some countries, this hasallowed hedge funds and products withhedge fund-like characteristics to bemade more available to retail investors.

For the first time, we have included adetailed consideration of the taxation ofhedge funds across the market place inEurope, as well as an overview of thevarious national tax regimes as theyaffect hedge fund managers and hedge

fund investors.

Notwithstanding that regulatory progressat the pan-European level remains slow,we are of the view that the relaxation ofregulatory and fiscal barriers, combinedwith improved corporate governancearrangements (whether enforced byregulators or adopted voluntarilyby funds boards of directors), willresult in further rapid growth in theEuropean hedge fund market over thecoming years.

As always, hedge fund managers andpromoters themselves have a role toplay in shaping the regulatory and fiscalenvironment in which European hedge

funds operate. Apart from being activein consulting and influencing theappropriate authorities, the industryshould continue to develop best practiceguidance. The implementation by fundsboards and their service providers ofprocedures that follow such guidancewill serve to strengthen the appealof the hedge fund sector to investors ofall types.

Graham P.N. PhillipsEuropean Hedge Fund Practice LeaderPartner, PricewaterhouseCoopers LLPLondonJune 2005

I am pleased to present the 2005 edition of our report on theRegulation and Distribution of Hedge Funds in Europe.This is the third year that we have produced this report, whichrepresents a key part of PricewaterhouseCoopers commitmentto thought leadership in the European hedge fund industry.

Foreword

This paper was prepared with input from hedge fund

specialists of PricewaterhouseCoopers Global

Alternative Investment Management Industry Group.

Compilation of such a paper, which covers up to the

minute developments across many countries, requires

a high degree of cross-border collaboration and

thanks are due to the PricewaterhouseCoopers

international network for their input.

While this information represents our understanding

at the time of going to press, given the rapid pace of

change in the European hedge fund industry, the

factual data in this paper may quickly be superseded.

Up-to-date advice should always be obtained

regarding current regulations and fiscal rules.


4/40


Section 1

The composition of the investor baseproviding the flow of new money into thissector is changing: increasingly, hedgefunds and hedge fund-like products are

available to mass affluent investors andsome are even available to retailinvestors, although access is typicallyvia funds-of-hedge funds rather thandirectly into single manager hedge funds.There is also increasing interest fromEuropean institutions as they seek tobalance their fiduciary responsibilities tounderlying investors or stakeholdersagainst the investment drivers of diversityand alpha returns.

Rapid growth of the asset class, theentrance of new investors to the hedge

fund market, concerns about the effectsof competition between prime brokers forlending and the effects of hedge funds onmarket stability, continue to exercise theminds of regulatory authorities acrossEurope. Individual national regulatorshave reacted in different ways and noconsensus is emerging, so it is notsurprising that progress at thepan-European level remains slow.

Regulation, fiscal rules or a combinationof both, still limit individual investorsparticipation in the sector, but the degree

to which this effectively prevents accessto hedge funds and hedge fund-like

products depends on which set ofnational rules applies to each investorand each fund. Interestingly, in somecountries, regulators and fiscal authorities

appear to be working towards a commonagenda with respect to encouraging ordiscouraging investment in hedge funds.However, this is not the case everywherein Europe.

It is not only the investor base that ischanging: strategies are evolving too andthe past year has seen European hedgefunds adopting certain of the lesscommon strategies already seen on theother side of the Atlantic, such asproviding loan origination, trading carboncredits and investing in reinsurance

assets and in deals that were previouslythe domain of private equity houses.

Choice of investment strategy does notonly affect the regulatory categorisationof the fund and therefore to who it can bedistributed, but it can also affect the taxtreatment of the fund. For new funds,thought is required at the developmentphase to ensure that an appropriate taxstructure is in place to achieve optimaltax treatment at both the fund andinvestor levels. The chosen structuremust be capable of withstanding

challenge from fiscal authorities who, liketheir regulatory counterparts, are showing

The hedge fund sector continues to grow rapidly: manycommentators are now estimating that global assets undermanagement have surpassed US$1 trillion and it is thought thatEuropean hedge funds contribute approximately a quarter of theglobal total, up from a fifth a year ago.

Current developments in the hedge fund market


5/40


an increasing understanding of, andinterest in, the hedge fund sector.

Another effect of regulators interest inthe sector is the increased recognitionby hedge fund boards of directors of theirresponsibilities to shareholders andthe attention that they need to pay togovernance arrangements, particularlywith regard to their monitoring of the

services provided to the fund by thirdparties, including the investmentmanager. Given that failure to controloperational risk has contributed tomany hedge fund failures, this is anencouraging sign and one that will nodoubt be applauded by investors,who are naturally concerned that thereshould be responsible stewardship oftheir money.

The above diagram illustrates the variousinfluences on the development of themarket for hedge funds. Where all three

influences converge, we expect that themarket for hedge funds will be at its mostconducive for growth.

So where is European hedge fundregulation heading? We expect that themodel that will develop over the longer

term is one where the market for hedgefunds and hedge fund-like products willbe determined by regulations that mapinvestor classes against levels of riskinherent in the investment proposition.We consider it likely that this mappingwill be based on outputs, for example,a promised rate of return to shareholders,rather than inputs, being how theinvestment portfolio is structured to

deliver outputs. However, a pan-European model along these lines isa long way off and we do not envisagethat a retail market for hedge fundscomparable with the market that alreadyexists for mutual funds in Europe willdevelop in the foreseeable future.

Despite this, hedge fund managersand promoters have an important role toplay in shaping the future regulatorylandscape by, for example, respondingto regulators consultation papersand making use of industry-wide

representation through bodies such asAIMA. The industry should also considersetting voluntary standards in such areasas control of operational risk, valuationsand fund corporate governance.

Stronger corporategovernance framework

Market growth

Negative investorsentiment caused

by high profilefund failures

Certain strategies/assets notacceptablein regulatedfunds

Tax disincentivesprevent market

penetration

Regulation is morefocussed on outputs

Reducing taxdiscrimination against

hedge funds

Most conducive conditions for development of the

market for hedge funds

Diagram 1: Influences on the development of the marketfor hedge funds

CORPO

RATE GOVERNANCE

REGULATIO

N

TAX


6/40


Section 2

European regulatory framework

There is increasing interest in hedgefunds from the pan-European authorities.For example, a response to the reportby the European Parliaments Committeeon Economic and Monetary Affairs onthe Future of Hedge Funds andDerivatives (the Purvis report, October2003) is due in Summer 2005. TheEuropean Commission will also comment

on the conclusions of its AssetManagement Forum, which, it hasrecently been reported in the financialpress, will include consideration ofwhether a new pan-European regulatoryframework for hedge funds is desirable.

Indications are that the EuropeanCommission is not keen to introduce newlegislation but may seek to make smallbut significant alterations to the UCITSand MiFID Directives to embrace hedgefunds. They could, for example, ask theCommittee of European Securities

Regulators (CESR) for advice onsituations where hedge funds could beconsidered suitable as an investmentrecommendation by an adviser.

The underlying problem, which none ofthe regulators are grasping, is that manyhedge funds, although operating asunauthorised vehicles, are inherently lessrisky in investment terms than manylong-only UCITS.

What is required is for UCITS rules to bedeconstructed into:

structural and operational featuresthat bring investor protection

for example, authorisation of theinvestment manager, requirementto have a depository with oversightresponsibilities, and rules onNAV/pricing; and

investment constraints that protectinvestors these are currently definedby investment and borrowing powers,but in the future should be defined byagreed risk measures.

Such an approach would allowinvestors to choose the amount ofoperational risk that they are preparedto accept in a fund structure separatelyfrom the investment risk they areprepared to bear.

The proposals by CESR on UCITS-eligible assets suggest that regulatorsare fixated by the legal definition oftransferable securities rather thanconsidering the economic effect ofvarious instruments. So progress at apan-European level may be rather slow.

Retailisation of hedge fundsand hedge fund-like products

With the hedge fund industrys rapidexpansion in recent years, there has alsobeen an extension of the industrys targetmarket, with greater access to retailinvestors across Europe. Greaterregulatory hurdles have accompanied theretailisation of the market; however, anumber of countries are leading the wayin increasing the accessibility of hedge

funds and hedge fund-like products toretail investors. Retail access to date has

Pan-European regulatory developments


7/40


mainly been through funds-of-hedge

funds, although wrapper products linkedto underlying hedge funds dominate incertain markets. Notwithstanding this,the vast majority of European hedgefunds (whether by number or by assetsunder management) remain accessibleonly via private placements witha sizeable minimum investment.Finalisation of what eligible assets areallowed under UCITS III is likely to havea big impact on the further developmentof a market for hedge fund-like productsaimed at retail investors.

In the UK, despite the general premise inlocal regulation that hedge funds shouldnot be promoted to the public, there area number of hedge fund-like productsthat are aimed at, and promoted to,the retail market in the UK. These havetypically been structured as UK listedcompanies which act as ISA-ablewrappers for a fund-of-hedge fundsproviding hedge fund exposure. Severallarge investment management firms havealready launched such products.

A fund with certain hedge fund-like

characteristics can now be authorisedby the Financial Services Authority (FSA)as either a Qualified Investor Schemeor a non-UCITS retail scheme. To dateneither route has been used extensively,however, the HM Revenue & Customs(HMRC) has now clarified that thesevehicles will generally be taxed in thesame manner as authorised unit trustsand OEICs, so we expect to see more ofthese vehicles coming to market in thenear future. At the time of going to press,we are aware of several new funds aimedat retail investors, some of which areintending to list on AIM (the junior

market in the UK), which will apparently

fall under one of these regulatorycategories. One example that we haveseen requires a minimum monthlyinvestment of only 250.

The FSA has confirmed that it will bepublishing a further review of thepromotion and distribution of hedgefunds in the UK. This may result insome relaxation in the rules for hedgefund promotion.

Germany has a general prohibitionon retail distribution of single manager

hedge funds; however, indirect routes areavailable to retail investors such asstructured notes linked to underlyinghedge funds. The situation is similar inSwitzerland, where funds-of-hedgefunds are also accessible to retailinvestors. In Luxembourg, retail investorshave access to hedge funds, providedthe funds are approved by the localregulator. Last year, the Irish regulatorabolished its minimum investment limitsfor Irish retail investors in funds-of-hedgefunds. France is also easing access toretail investors with a minimum

investment threshold of 10,000 forfunds-of-hedge funds.

Overall, as investors are seeking newproducts to achieve a better andmore transparent balance betweenperformance and risk, we expect retaildemand for hedge funds and hedgefund-like products to increase. In the faceof such demand, it is to be hoped thatthe regulatory barriers to marketing toretail investors will continue to be eased,but most regulators across Europe stillappear to be treading carefully.

A number of countries are leading the wayin increasing the accessibility of hedge fundsand hedge fund-like products to retailinvestors... Notwithstanding this, the vastmajority of European hedge funds remainaccessible only via private placements with

a sizeable minimum investment.


8/40


Practical aspects of UCITS IIIimplementation

The implementation of UCITS III acrossthe European Union (EU) offers thepossibility of a pan-EU passport forhedge fund-like products launched byhedge fund managers and establishedinstitutions alike, provided that suchproducts satisfy the UCITS Directive.

The availability of such a passport shouldsignificantly reduce the barriers to costeffective retail cross-border distribution ofsuch products by limiting the regulatoryburden associated with the need toensure compliance with different sets ofregulations issued by a plethora ofnational regulators.

In practice however, regulators acrossthe EU have so far shown differinginterpretations of the UCITS III Directives,especially in relation to transitionalimplementation rules, the definition of

eligible assets and other practical issues,the net result being confusion and delay.

This lack of a common approach hasresulted in the European Commissionissuing various recommendations,including those issued in April 2004 onthe use of derivatives in UCITS IIIproducts, in an attempt to introduce alevel playing field throughout the EU.

In a more recent development on thesame aspect of UCITS III implementation,the European Commission has requested

technical advice from CESR on theclarification of which eligible assetsmay be held as investments by UCITS IIIfunds. On 18 March 2005, CESRpublished a consultation papercontaining draft advice, in particular onthe eligibility of structured financialinstruments, money market instrumentswhich are not dealt on a regulated marketand (subject to certain constraints)credit derivatives.

It is likely that the EuropeanCommission will follow CESRs final

recommendations. Certain hedgefund-like strategies including some

employed by existing UCITS funds willno longer be available to managers ofUCITS funds should CESRs draft adviceas it currently stands be adopted by theEuropean Commission. Managers ofhedge fund-like products should seek tocontinue to influence CESR as theadvantages afforded by an EU-widepassport are significant.

Prudential regulation in the

European Economic Area

Asset managers operating in theEuropean Economic Area (EEA) arerequired by their regulators to complywith the capital adequacy rules based onthe European Unions Capital AdequacyDirective (CAD). For hedge fundmanagers in the EEA, national regulatorsgenerally require that the equivalent of13 weeks expenditure is maintained asliquid capital.

CAD is to be amended by the CapitalRequirements Directive which is due tobe passed by the European Parliament in2005 for implementation in 2007. Thebasic requirement for most hedge fundmanagers is likely to remain, howeveradditional capital may be required tomeet any special risks faced by individualhedge fund managers.

Supervision by national regulators withinthe EEA also applies at a consolidatedlevel where a regulated firm is part of afinancial group in the EEA, althoughwaivers may be available from thegeneral requirement to maintain specifiedlevels of capital for the group as a whole.

The Financial Conglomerates Directiveis being implemented in 2005 and willextend the consolidated supervisionregime to include parent companies andfellow subsidiaries outside the EEA andgroups that include an insurancecompany. It remains unclear how, inpractice, European regulators will seek toimpose any additional capital - orsystems and controls - requirements onsuch groups.

Certain hedge fund-likestrategies... will nolonger be available tomanagers of UCITSfunds should CESRsdraft advice as it

currently stands beadopted by theEuropean Commission.


9/40


Conduct of Business Rules inthe European Economic Area

The conduct of business rules with whichhedge fund managers operating in theEEA must comply are currently based onthe EUs Investment Services Directive(ISD). The ISD contains only high-levelrequirements and there has beenconsiderable variation in the manner inwhich national regulators have applied

detailed conduct of business rules.

The Markets in Financial InstrumentsDirective (MiFID) is likely to beimplemented in April 2007 and willrequire EU member states to amend theirconduct of business rules. Areas affectedare likely to include best execution andcompliance arrangements. In addition,the provision of investment advicebecomes a core activity affectingdistribution right across Europe.

EU Savings DirectiveThe key aim of the EU Savings Directive,which will be fully implemented by1 July 2005, is the exchange ofinformation between EU member stateson cross-border payments of interest toindividuals. The Savings Directiverequires that local paying agents report(or withhold tax on) relevant paymentsto EU-resident individual investors,which could include distributions andredemptions from hedge funds that areinvested in fixed income products.

Many of the offshore jurisdictions thathave traditionally attracted investorswishing to retain their privacy havealso agreed to implement theSavings Directive1 and equivalentreporting/withholding obligations willalso apply to paying agents located inthese jurisdictions.

Recent interpretations by a number ofEuropean and offshore tax authoritiessuch as the UK, Guernsey, Ireland andSwitzerland suggest that more hedgefunds than previously thought will falloutside the scope of the Savings

Directive. However, managers will stillneed to identify which of their funds arelikely to be affected, identify the relevantpaying agent(s) in their operationalstructure, and ensure that appropriatesteps are taken to address the SavingsDirective. This includes communicationwith investors about the status of thefund under the Savings Directive.

Data Protection issues

Data protection regulations are designedto protect the privacy of personalinformation relating to individuals.As hedge fund products become morewidely available to individuals, gettingdata protection compliance right isbecoming more challenging.

Under EU data protection laws, there isan overriding duty to process personaldata fairly and lawfully, which meansobtaining the consent of the individualsunless certain other conditions can be

satisfied. Additionally, individuals mustbe kept informed of how their personaldata is being used and to whom it isbeing disclosed. Processes must beput in place by all those who handledata relating to hedge funds to allowindividuals to access their personal dataupon request.

The role of the different parties involvedin the operational structure of any hedgefund must be considered from a dataprotection perspective to determinewhich parties may be required to comply

with EU legislation and what contractualdocumentation must be put in place.For example, the fund administrator mustbe contractually bound to implementappropriate measures to protect the dataagainst loss or damage, and to ensurethat it acts only on the instructions ofappropriately authorised persons.

Generally, EEA-based transferors ofpersonal data may only transfer suchdata to transferees in other EEA countriesor to countries which are deemed to havein place legislation providing an adequate

level of protection to personal data, forexample Switzerland. Therefore, where

1 For example, British Virgin Islands, the Cayman

Islands, Guernsey, Jersey and the Isle of Man.Bermuda has not agreed to implement the Directive.

MiFID... will require EUmember states toamend conduct ofbusiness rules. Areasaffected are likely toinclude best execution

and compliancearrangements.


10/40


any party, for example, an offshore

administrator, to whom data may bedisclosed is not located in the EEA or ina jurisdiction with equivalent protection,consideration must be given to methodsof how this restriction can be overcome.

The USA is not deemed to havelegislation providing adequate protection,however, a specific exemption isavailable: the European Commissionhas approved the US Safe Harborscheme and no breach will be committedby an EEA-based transferor whotransfers personal data to a US-based

transferee who has signed up tothese arrangements.

Similarly, where a transferee is located inany other non-EEA country with domesticlegislation that has not been deemedto provide adequate protection, it ispossible for the transferor to avoidcommitting a breach by requiring thetransferee to enter into a contract basedon the European Commissions standardcontractual clauses, which are designedto bring the level of protection up to anacceptable level.

As a result of some disparity in theimplementation of national dataprotection laws across the EU (includingthe ten countries that acceded tothe EU in May 2004), data protectionrequirements are more onerous insome countries than in others.In particular, security and registrationrequirements can vary significantlybetween member states.

Freedom of Information

In a separate development, the UKsFreedom of Information Act 2000 (FOIA)has significant implications for theconfidentiality of commercially sensitivedata held by public authorities. Under theFOIA, a general statutory right for thirdparties to be given access to informationheld by any public authority in the UKcame into being on 1 January 2005.

Managers of hedge funds, regardless oftheir own domicile or that of the fundsthat they manage, will need to consider

carefully if any of their UK investors fallwithin the FOIAs definition of publicauthority. This is very broad andincludes both central and localgovernment, as well as other publicbodies in the UK such as governmentagencies and some quasi-autonomousgovernmental organisations, otherwiseknown as quangos. Importantly, thesebodies associated pension funds mayalso be subject to the FOIA and some ofthese may have a portion of their assetsinvested in hedge fund products.

Hedge fund managers whose funds areinvested in by UK public authorities needto consider how to limit the risk that theFOIAs access rights create, for exampleby limiting the amount of informationprovided and/or by specifying anysensitive information as confidential,in order to take advantage (as far aspossible) of certain exemptions thatare available under the FOIA.

As hedge fundproducts becomemore widely availableto individuals, gettingdata protectioncompliance right isbecoming morechallenging.


11/40

Section 3

However, there is broad pressure byindustry bodies for removal of tax barriersfor investment in UCITS funds which mayhave follow-on implications for hedgefund investment.

Taxation of hedge funds

In terms of the taxation of a domestichedge fund itself, no jurisdiction hasestablished a specific tax regime to caterfor domestic hedge funds or hedgefund-like products, relying instead on theexisting tax regime. Typically, hedgefunds are either:

taxed at concessionary rates or taxexempt at the fund level in the samemanner as other collective investmentschemes, provided certain criteria aresatisfied; or

treated as tax transparent such thattax is levied at the investor level.

Taxation of investors

Each territory has implemented its owntax treatment of hedge fund returns foreach investor class. In some territories,the tax treatment of hedge fund investors

is the result of a considered review bythe local tax authorities. In many otherterritories, there is no specific tax regimefor the treatment of hedge fund returns,largely due to the fact that they are arelatively new investment vehicle for mostinvestor classes. Therefore, general localtax principles apply or the return may betaxed in a similar manner to returns fromother collective investment schemes, forexample, UCITS funds.

Tax barriers to investment

Our 2005 research revealed that there

have been significant initiatives byvarious local tax authorities to remove taxbarriers to the distribution of foreignhedge funds, notably by Austria,Denmark and Germany. This is largelydue to the pressure that industry bodies,the European Commission and thedeveloping body of EU case law(which attacks the provision by local taxauthorities of tax incentives to domesticfunds) have placed on EU financeministers in relation to the reductionof tax discrimination against foreignUCITS funds.

As most participants in the hedge fund industry will be aware,there is no harmonised tax treatment of hedge funds, hedgefund-like products and hedge fund investors within the EuropeanUnion and no pan-European proposals for tax harmonisation onthe horizon.

Current developments in the taxation of hedge funds,hedge fund managers and hedge fund investors



12/40


However, in many countries, tax stillremains either a direct or indirect barrierto hedge fund distribution. For example,Ireland, Italy and Portugal all have rulesthat tax investments in foreign hedgefunds less favourably than investmentsin domestic hedge funds; and Austria,Germany and the UK have local laws thatrequire foreign funds to comply with localadministrative requirements. To the extentthat such local requirements are overlyburdensome to the fund promoter, theymay constitute indirect discriminationagainst foreign funds.

Figure 1 highlights the tax barriers todistribution of foreign hedge funds tovarious investor classes when comparedto the tax treatment of domestichedge funds.

Another area of tax discrimination that isoften overlooked by investors and fundpromoters is the tax credit systems ina number of EU territories. Many EU taxcredit systems allow withholding tax anddomestic credits to flow through todomestic investors or funds only, suchthat a local investor investing in domesticassets via a foreign fund may suffer fullwithholding tax rates.

Surprisingly, results from severalterritories indicate that investing in aforeign hedge fund could actually bemore tax effective than investing in adomestic hedge fund if the foreign hedgefund investment attracts the operation ofa participation exemption which resultsin investors being exempt from incomeand/or capital gains tax if the investmentis above a certain threshold. In practice,this benefit may not often be obtainedgiven the investment sizes required toaccess the participation exemption.

Historically, investors resident incountries where direct investment wasrestricted by regulation or was inefficientfrom a tax perspective, sought to investin hedge funds via wrapper instrumentssuch as structured notes issued by banks(with performance tied to the underlyingfund). As regulators increasingly allowinvestors to invest directly in either

domestic or foreign hedge funds(especially via funds-of-hedge funds),and as tax barriers to investment areremoved, one might expect thatinvestment via tax wrapper productswould decrease. However, the resultsof our research revealed that in somecountries investing via a wrapperstructure may achieve a better tax returnfor the investor (for example, by obtainingcapital gains tax treatment which in somecountries is more beneficial) or ease theadministrative burden of complying withlocal reporting requirements. Therefore,the use of wrappers is still worthconsidering when marketing hedge fundsto investors.

VAT

There is a concept in VAT legislationthat carrying on a business throughan agency can give rise to a VATestablishment for that business in the EUmember state where the agent is located.

Our research has confirmed that thisconcept is generally not applied bythe tax authorities to domestic fundmanagers of foreign hedge funds, andtherefore foreign hedge funds are notbrought onshore for VAT purposes byvirtue of the activities of a domesticfund manager.

The 6th VAT Directive allows formanagement services to specialinvestment funds as defined by EUmember states to be exempt from VAT.It would appear that in EU member states

such as Austria, Denmark, Germany,Ireland, Italy, Luxembourg, Netherlands,Portugal and Sweden, if onshore hedgefunds are correctly structured, investmentmanagement services could fall withinthe scope of this exemption. Therefore,when setting up a domestic hedge fund,consideration should be given to thelocation of both the hedge fund and itsinvestment manager as it may bepossible to arbitrage the VAT treatmentof management services cross-border.

There have beensignificant initiativesby various local taxauthorities to removetax barriers todistribution of foreign

hedge funds.


13/40


HNWI Pension fund Corporate BankLife insurance

company

Austria

Belgium

Bermuda

Cayman Islands

Denmark

Finland

France

Germany

Gibraltar

Greece

Guernsey

Ireland

Isle of Man

Italy

Jersey

Luxembourg

Malta

Netherlands

Netherlands Antilles

Norway

Portugal

Russia

Spain

Sweden

Switzerland

UK

USA

Figure 1: Tax barriers to the distribution of hedge funds

No tax discrimination against foreignhedge fund

More favourable treatment for foreignhedge fund

Direct tax discrimination against foreign hedge fund

Not likely to be a significant investor class; investment in hedge funds notpermitted; or there are no domestic hedge funds

Indirect tax discrimination againstforeign hedge fund


14/40


Section 4

EUROPE

AUSTRIA

Regulation

Domestic and foreign funds-of-hedgefunds may be distributed to both retailand institutional investors in Austria.Austrian regulation prevents thelaunch of domestic single-managerhedge funds. Foreign single-managerhedge funds may be distributed toretail and institutional investors,subject to approval from the FMA(Financial Market Authority). Thisapproval is conditional upon certainfeatures of the fund; for example, afund undertaking uncovered shortselling would not be approved.

Taxation

In December 2004 a new law waspassed that eliminated the differenttax treatment of income from foreignand domestic funds. From 1 July2005, Austrian banks will deducta final 25% withholding tax ondistributions and deemeddistributions from foreign funds(calculated by a local tax representative)such that they will be taxed on thesame basis as domestic fundsprovided that the followingrequirements are met:

1. The foreign hedge fund has appointeda local tax representative to calculatedeemed income distributions on anannual basis and has provided theOesterreichische Kontrollbank (OeKB)with this information four months afterthe financial year end; and

2. Net interest income figures areprovided on a daily basis to theOeKB, and the fund confirms tothe Austrian Ministry of Financethat they have been calculatedand published in accordance

with Austrian tax law.

Therefore, individual investorsare subject to tax on income1

distributions and deemed incomedistributions from hedge fundinvestments at the rate of 25%2

(provided the foreign fund hasappointed a local tax representativeand complies with informationreporting requirements). Capital gainsrealised on the disposal of equitiesare taxed at an effective rate of 5%whilst capital gains on the disposalof bonds are tax free.

Country by country overview: Regulationof hedge funds and taxation of hedge fundinvestors at May 2005

1 Dividends, interest and ordinary income less

expenses.2 This will be a 25% final withholding tax if there is alocal depository.


15/40


If individual investors dispose ofinterests in the fund within one yearof acquisition, the gain is subject toprogressive income tax as speculativeincome (up to a maximum rateof 50%).

Corporates, banks and insurancecompanies are taxed at 25% on bothincome and capital gains from hedgefund investments. Special rules couldapply for insurance companies.However, realised capital gains ofdomestic funds are only taxable forcorporate investors when distributed;the total realised gains of foreignfunds are taxable even if they arenot distributed.

Austrian pension funds are exemptfrom tax in Austria.

The safeguard tax of 1.5% that wasdeducted by the Austrian depositorybank if an Austrian investor heldshares in a foreign hedge fund willalso not apply if the above conditionsare met.

If a foreign fund has not appointeda local tax representative, it will betreated as a black fund and allinvestors (except pension funds) will

be subject to unfavourable lump sumtaxation whereby all distributionsreceived plus the higher of:

(i) 10% of the last redemption price inthe calendar year; or

(ii) 90% of the difference between thefirst and the last redemption pricein the calendar year,

will be subject to 25% tax.

If foreign funds do not appoint anAustrian tax representative, theAustrian investor will now be able toprovide the tax authorities withinformation on deemed distributedincome to avoid lump sum taxation(previously such information couldonly be provided by an Austrian taxrepresentative officially appointedby the fund), although it is verydifficult for the individual to calculatethese figures.

BELGIUM

Regulation

Hedge funds cannot be publiclydistributed to retail investors inBelgium. Access to hedge fund-likeproducts for retail investors is limitedto UCITS III funds which may, forexample, invest in hedge funds or anindex of hedge funds, subject tocertain diversification requirements.

Foreign and domestic hedge fundsmay be distributed to investors willing

to subscribe a minimum of 250,000.

Taxation

Individuals and pension fundsinvesting in foreign hedge funds(which are non-transparent) are taxedat 25% or subject to 15% withholdingtax. Capital gains are exempt fromtax unless individual investors holdinvestments for speculative purposes.

Corporates, banks and insurancecompanies are taxed on income and

capital gains from hedge funds at33.99% on an accruals basis.Pension fund investors in domestichedge funds are not taxed.

As noted above, direct investmentby retail investors in domestic hedgefunds is currently not allowed.Accordingly, indirect investmentvia wrapper instruments is used.The specific tax treatment dependson the type of wrapper.


16/40


DENMARK

Regulation

Foreign hedge funds are required toobtain approval from the DanishFinancial Supervisory Authority fordistribution. Proposals currentlybefore the Danish Parliament, ifenacted, would permit the creationof domestic hedge funds, subjectto approval and licensing by theDanish FSA.

Taxation

New legislation3 is expected to beenacted in June 2005 (to apply from 1January 2005) which will result in thetaxation of investors in domestic andforeign funds effectively being aligned(i.e. removal of tax discriminationagainst foreign funds).

Under the new rules, individualinvestors, corporates, life and general

insurance companies will be taxed ondividend distributions and unrealisedcapital gains4 (individuals up to 59%,others 28%).

Pension funds and life insurancecompanies are subject to a specialpension tax regime and taxed at arate of 15% on the net yields frominvestment on a mark-to-marketbasis. Special rules ensure that lifeinsurance companies are not subjectto double taxation.

FINLAND

Regulation

Both domestic and foreign hedgefunds may be distributed toprofessional investors. In the caseof foreign funds marketing tonon-professional investors in Finland,a licence must be obtained from theFinancial Supervision Authority.

Taxation

Individual investors are taxed annuallyon their portion of the realised incomeof a hedge fund structured as apartnership at either 28% orprogressive rates. If a hedge fund isstructured as a (special) commonfund, the investor is taxed at 28% ondistributions or redemptions. If anon-Finnish hedge fund is structuredas a company (that is similar to aFinnish company form) the return istaxed as a dividend generally at

progressive rates when received5.

Corporates, pension funds, banksand insurance companies are taxedannually on their portion of therealised income of the hedge fundstructured as a partnership. Wherethe hedge fund is structured as a(special) common fund, theseinvestors are taxed at 26% upondistribution or redemptions6. If anon-Finnish hedge fund is structuredas a company (that is similar to aFinnish company form) the return is

taxed as a dividend and generallytaxed at 26% when the dividendis received7.

3 Bill introduced into Parliament in February 2005which contains new rules for investments in fundsand certain investment companies.

4 Taxed on the difference between the value of theshares at the beginning of the year and the end ofthe year.

5,7 Where a fund structured as a company would bea tax treaty resident or a company referred to inthe Parent/Subsidiary Directive, then a portion ofthe dividend may be tax exempt and a portiontaxed as income at 28%.

6 Non-Finnish funds with characteristics similar tospecial common funds will be treated as a specialcommon fund for Finnish tax purposes.


17/40


FRANCE

Regulation

In December 2004, the Autorit desMarchs Financier (AMF) issued newregulations affecting how domestichedge funds and hedge fund-likeproducts regulated as eitherAuthorised Funds with SimplifiedInvestment Rules (OPCVM Agres aRegles dInvestissement Allges ARIA) or Contractual Mutual Funds(OPCVM Contractuels) under theFinancial Securities Act of 2004 maybe marketed to different categories ofinvestors including retail investors.

There are three types of ARIA fund:

1. Simple funds are subject tocertain rules relating todiversification of holdings and mayleverage up to 200% of net assets.Investors with a minimum net worthof 1 million or a minimum of one

year of relevant work experienceare subject to a minimuminvestment threshold of 10,000.Other individual investors arerequired to make a minimuminvestment of 125,000.

2. Leveraged funds are subjectto identical rules regardingdiversification and minimuminvestment thresholds as Simplefunds, but may leverage up to400% of net assets.

3. Fund-of-alternative funds mayleverage up to 200% of net assetsand are required to invest in aminimum of 16 underlying funds.Where investors are provided witha guarantee of capital preservation,there is no minimum investmentthreshold. Otherwise, there is aminimum investment thresholdof 10,000.

Contractual Mutual Funds arenot subject to rules relating todiversification of holdings or a limit onthe amount of leverage they mayemploy. Investors with a minimum networth of 1 million or a minimum ofone year of relevant work experienceare subject to a minimum investmentthreshold of 30,000. Other individualinvestors are required to make aminimum investment of 250,000.To operate Contractual Mutual Funds,investment managers must bepre-approved by the AMF.

Taxation

The new French legislation referred toabove mainly deals with regulatoryissues. Currently, the taxation rulesare applied based on the existingOPCVM taxation principles (French

UCITS), which provide for taxexemption at the level of the fund (taxtransparency). New tax provisions arelikely to be implemented in the nextcouple of years to specifically addressthe taxation of hedge funds.

Individuals are taxed on receipt atmarginal income tax rates (up to56%); or on capital gains at 27%(including social contributions).

Corporates, banks and insurancecompanies are taxed on receipt of

dividends and taxed annually on theliquidation value of the shares (on amark-to-market basis). Generally,pension funds may benefit from totaltax exemption on capital gains andsuffer a maximum 24% taxation onother income.

French investors in foreign funds arenormally taxed on the same basisdepending upon the French taxanalysis of the funds status.


18/40


GERMANY

Regulation

The Investment Act 2004 hasintroduced a new regime coveringboth single-manager hedge funds andfund-of-hedge funds. single managerfunds, both domestic and foreign,may not be publicly distributed.Foreign funds-of-hedge fundsmay be publicly distributed inGermany once registered with theregulator, the Bundesanstalt frFinanzdienstleistungsaufsicht (BaFin).Registration will only be granted incases where BaFin considers thathome state regulation is effective andthe home state regulator is preparedto co-operate satisfactorily with BaFin.

In certain cases, BaFin has imposedlicencing requirements on offshoreissuers of wrapper products and SPVstructures for rendering cross-borderbanking commission services. Thefuture development of this practice isstill unclear.

The Investment Act 2004 andsubsequent decrees allow for thecross-border appointment of primebrokers and fund administratorswithin the EU for domesticsingle-manager funds. Additionally,German regulations allow assetmanagement functions to bedelegated to investment managersestablished outside Germany withinthe EU or in third countries, providedthey are subject to effective homestate supervision.

Based on the final decree of theGerman insurance regulator,Anlageverordnung (AnlV), insurancecompanies may invest up to 5% ofcommitted assets in domestic hedgefunds and funds-of-hedge funds, andin EEA-domiciled hedge funds andfunds-of-hedge funds that are subjectto supervision in their home country.Additionally, insurance companies

may invest in hedge funds indirectlyvia regulated mixed funds, which caninvest up to 10% of their net assetvalue in domestic and foreign

single-manager hedge funds. Indirectinvestments in hedge funds are alsopossible via wrapper products issuedby EEA-domiciled hedge funds andfunds-of-hedge funds.

Taxation

A new tax law governing the taxationof fund investors came into effect atthe end of 2003. It applies to all fundswith year ends after 31 December2003 and classifies the funds aseither transparent or non-transparent,depending on the funds level oftax reporting. The new tax rulesabolish the prior discriminationagainst foreign funds.

The most noteworthy tax reportingobligation for German and foreignfunds is that a tax transparent fund

has to determine income/capital gainsunder German tax law.

Funds will only be treated as taxtransparent if:

- the fund calculates taxable incomein accordance with German law;

- the fund calculates and publishesdistributed and accumulatedincome;

- the fund obtains a taxcertificate; and

- the fund files tax returns with theGerman authorities upon request.

A tax adviser, an auditor orcomparable professional has to certifythat the funds German tax reportingis in line with German tax law. Thereare penalties for incorrect reporting.

In March 2005, the German taxauthorities published the third draftversion of a decree on the taxation ofinvestment funds and the required

compliance with reportingrequirements which determinewhether a fund (domestic or foreign)

can be treated as tax transparent.The final version of this importantdecree of, at present, more than100 pages, is expected at the end ofMay 2005.

Dividend, interest and other income(less expenses) generated by an

accumulating fund will accrue to theGerman investor as a deemeddistribution at the business year-endof the transparent fund. Capital gainsgenerated by an accumulating funddo not accrue to the investor as partof the deemed distribution.

Individual investors are taxed ondistributed/accumulated incomegenerated by the hedge fund atmarginal income tax rates between15% and 42%. Income fromdividends generated by the fund is

50% tax free. Capital gains from thesale/redemption of hedge fundinvestments by individual investorsare tax free after a one-yearholding period.

Corporates and banks are taxed at25% on distributed/accumulatedincome generated by the hedge fund.The same tax rate applies to capitalgains from the sale/redemptionof hedge fund investments. However,there is an exception: dividends andcapital gains from long equity

investments generated by the fundare 95% tax-free at the investor level,whether distributed by the fund orrealised by the investor uponsale/redemption of the investment inthe hedge fund.

Pension funds and insurancecompanies are taxed at 25% ondistributed/accumulated incomegenerated by the hedge fund.Capital gains from thesale/redemption of hedge fundinvestments are fully taxable.


19/40


Investors who hold non-transparentfunds at the end of the calendar yearare subject to punitive lump-sumtaxation irrespective of the fundsactual income or capital gains.

The investor in an accumulatingnon-transparent fund is taxed on 70%of the positive increase between thefirst and the last NAV of the fund inthe calendar year. At least 6% of thelast NAV of the fund in the calendaryear is taxable, even if the fund NAVdecreased during the calendar year.The tax rates are the same asmentioned above.

GIBRALTAR

Regulation

No domestic or foreign hedge fund orfunds-of-hedge funds may currentlybe marketed publicly in Gibraltar.

Taxation

Individual investors investing intohedge funds and funds-of-hedge

funds are taxed, on a receipts basis,at a tax rate of up to 45%. Capitalgains are exempt.

Banks, insurance companies (non-lifebusiness) and corporates are taxedon income from hedge fundinvestments at the rate of 35% unlessexempt company status8 is adopted.

GREECE

Regulation

Domestic funds are regulatedaccording to their legal form, however,Greek legislation effectively preventsthe establishment of domestic hedgefunds. For distribution of foreignhedge funds, the regulationsapplicable to all non-UCITS funds willapply, i.e. distribution is subject to thegranting of a license by the CapitalMarkets Committee and marketing tothe public in Greece may only beperformed through banks, insurancecompanies or investment servicescompanies acting as representatives.This restriction does not apply todistribution by private placementwhich is outside the scope of theregulatory framework.

Taxation

Individuals are taxed based on a tax

scale ranging from 15% (for incomeexceeding 9,500) to 40% (for incomeexceeding 23,000). Individualinvestors are not taxed on incomeand capital gains from UCITS funds.For non-UCITS funds, in the absenceof any special provision, the taxationwill depend on the legal form of thefund (but generally it is expected thatthe respective income would be fullytaxable at the rates above).

Corporates, banks and insurancecompanies are taxed on income and

capital gains from UCITS funds at32% (reducing to 25% in 2007) whenthe respective income and gains aredistributed by the above entities.Special rules determine how taxationmay be deferred by allocating theprofit which is not distributed to aspecial tax reserve. Pension funds areexempt from tax, although specialrules may apply depending on thetype of pension fund.

8Exempt company status is available until 2010 forexisting companies; 2007 for new companies.


20/40


GUERNSEY

Regulation

There are very few restrictions inGuernsey in respect of distributinghedge funds to local investors.

Qualified Investor Funds (QIFs) aresubject to a light touch regulatoryregime. QIFs, which are availableonly to professional investors, have

existed for some time now.

The QIF regime has recently beenmade even less onerous: regulatedadministrators can now self-certifyfunds, allowing regulatory approvalto be achieved in three days.As the regulatory burden falls onadministrators, there is an onus onthem to ensure that appropriate duediligence procedures are in place.

Taxation

Individual investors investing intohedge funds are taxed, on a receiptsbasis, at the rate of 20% on income.Capital gains are exempt.

Banks, insurance companies (non-lifebusiness) and corporate entities aretaxed on income from hedge fundinvestments at the rate of 20% on areceipts basis. Pension funds are nottaxed. Capital gains are exempt.

IRELAND

Regulation

The Irish Financial ServicesRegulatory Authority (IFSRA)continues to streamline the hedgefund approval process: there is nolonger a requirement for IFSRA topre-approve prime brokeragedocumentation provided that thefunds legal advisors certifycompliance with IFSRAs requirementsfor such documentation.

It is expected that IFSRA will soonfinalise its rules regarding the use ofprime brokers, such that QualifiedInvestor Funds (QIFs) will be allowedto hold all their assets with a primebroker rather than a custodian andProfessional Investor Funds (PIFs) willbe able to place their assets withprime brokers up to a limit of 140%of the funds borrowings from theprime broker. Any balance of assetsheld with the same prime brokerwill be required to be segregatedfrom the prime brokers own assetsin a separate custody accountand subject to a separatecustodian agreement.

A new Investment Funds, Companiesand Miscellaneous Provisions Bill willsoon be enacted. Firstly, the Billprovides the general legal frameworkfor the establishment of CommonContractual Funds (CCFs) which willallow for a new type of investmentvehicle the non-UCITS CCF.Secondly, it introduces segregatedliability at sub-fund level forinvestment companies; and thirdly, itallows for cross-investment betweensub-funds of investment companies.

For Irish-domiciled funds, limitson the minimum subscription forretail fund-of-hedge funds havebeen waived.

Irish company law is to be amendedto allow investment companies toproduce their accounts using USGAAP, Canadian GAAP, or JapaneseGAAP in addition to UK/Irish GAAPor IFRS which is currently permitted.

Taxation

Individual investors in hedge fundsare subject to tax on income at 20%and capital gains at 23% on areceipts basis. If the hedge fund islocated in a country outside the EUand with no double tax agreementwith Ireland (non-EU/non-DTA),individual investors will be taxed at42% (plus 5% social insurance) onincome and gains on a receipts basis(gains on disposal of units in a fundwhich has been designated by theIrish Revenue as a distributing fund

are liable to capital gains tax at 40%and are not liable to social insurance).

Corporate investors in hedge fundsare subject to tax on trading incomeat 12.5%, non-trading income at25% and capital gains at either12.5% or 23% (on a receipts basis).If the hedge fund is located in anon-EU/non-DTA country, corporateinvestors will be taxed on capitalgains at 40% (qualifying distributingfunds) or 25% (non-distributing funds)on a receipts basis.

Bank and insurance companyinvestors in hedge funds are subjectto tax on income and capital gainsat 12.5% on a mark-to-marketbasis. Pension fund investors aretax exempt.

Legislation introduced in the 2004Finance Act effectively ensures thatlocating the investment managementactivity of a hedge fund in Irelanddoes not give rise to an Irish taxexposure for the fund.


21/40


ISLE OF MAN

Regulation

There have been no recent changesto the regulatory environment in theIsle of Man.

Administration of ProfessionalInvestor Funds (PIFs) must be carriedout in the Isle of Man. However,PIFs are not subject to any further

Manx regulations.

Foreign funds may be administered inthe Isle of Man without being subjectto Manx regulation.

Taxation

Investors are not subject to tax in theIsle of Man.

The local tax regime is under review.With effect from 6 April 2006, it isexpected that all companies

(excluding licensed banks) will besubject to tax at 0%.

ITALY

Regulation

The only recent changes to theregulatory environment in Italy hasbeen the issue in April 2005 bythe Bank of Italy of regulationsimplementing the transitionalprovisions of the amending UCITSDirectives.

Domestic and foreign hedge funds arerequired to be authorised by the Bankof Italy.

The CONSOB (CommissioneNazionale per le Societa e la Borsa)regulates the distribution of foreignand domestic hedge funds.Distribution to individual investors isrestricted by way of a 500,000minimum investment requirement andby the fact that no public marketingis allowed.

Domestic hedge funds are requiredto appoint an Italian bank or an Italianbranch of a bank incorporated inanother EU member state as adepository bank.

Taxation

Individual investors in domestichedge funds are not subject to tax onincome from capital9. For individualsinvesting in foreign hedge funds,income is subject to tax atprogressive rates from 23-43%10.

Corporates, banks and insurancecompanies investing in domestichedge funds are subject tocorporation tax of 33% (with a taxcredit of 15% on income fromcapital)11. Corporates, banks andinsurance companies receivingincome from foreign funds are subjectto tax at 33%. Banks and insurancecompanies may also be subjectto regional tax under certaincircumstances on hedge fund income.

Pension funds are subject to taxat 12.5%.

JERSEY

Regulation

Following recent changes, ExpertFunds can now be self-certified byregulated service providers ratherthan being authorised individuallyby the regulator, as was previouslythe case.

We expect that there will be moves

over the next 18 months towards asimilar self-certification process forforeign funds.

A Code of Practice is expected to bepublished next year which will requirehedge fund managers located inJersey to have Professional IndemnityInsurance in place and to maintainliquid capital of three monthsannualised expenditure in additionto the current 25,000 capitalrequirement.

Taxation

Individual investors investing intohedge funds are taxed, on a receiptsbasis, at the rate of 20% on income.Capital gains are exempt.

Banks, insurance companies (non-lifebusiness) and corporate entities aretaxed on income from hedge fundinvestments at the rate of 20% on areceipts basis. Pension funds are nottaxed. Capital gains are exempt.

The local tax regime is under reviewbut no changes are expected tothe taxation of hedge funds. It isproposed that local tradingcompanies will be taxed at 0% andthere is a proposal to tax regulatedfinancial service providers at 10%from 2009 (although it is not expectedthat this will apply to local fundmanagers).

9 Income from capital broadly corresponds to theincrease in the net asset value of the fund accruedduring the period of ownership of the units.Proceeds arising from the disposal, the redemptionor the distribution of income in the hands ofindividual investors (that hold the units other than inconnection with a business activity) qualify asincome from capital. Any income received inexcess of capital qualifies as miscellaneous incomeand is subject to substitute tax at a rate of 12.5%.

10A withholding tax at a rate of 12.5% may belevied by Italian authorised intermediaries uponcollection as advance payment of total tax duefrom individuals, corporates, banks, insurancecompanies and pension funds.

11 The tax credit relates to the 12.5% substitute taxsuffered at the fund level.


22/40


LUXEMBOURG

Regulation

Retail investors and pension fundscan invest in hedge funds andfunds-of-hedge funds domiciled inany country, provided that the fund isapproved by the Commission deSurveillance du Secteur Financier(CSSF) for public offering. Only fundswhich are subject to home statesupervision which the CSSF deems tobe adequate will be approved.

New rules were enacted in July 2004which allow foreign funds to list onthe Luxembourg stock exchange.

The imminent implementationof the CSSFs circular on the useof derivatives in UCITS III funds,is expected to encourage thedevelopment of hedge fund-likeproducts.

Authorised hedge fund managersoperating in Luxembourg are notrequired to obtain authorisation foreach new fund that they launch.

Taxation

Individual investors are taxed onreceipt on income and net capitalgains from hedge fund investments attheir progressive tax rates up to amaximum of 39.95%.

Banks, insurance companies12 and

corporate entities are taxed uponreceipt on income and capital gainsfrom hedge fund investmentsat the rate of 30.38%. The EUParent/Subsidiary Directive may beavailable in respect of investments inEU hedge funds and funds-of-hedgefunds but would need to beconsidered on a case-by-case basis.

For pension fund investors, incomeand capital gains from hedge fundinvestments are included in theirtaxable base; however, pension

schemes generally are tax neutral.

MALTA

Regulation

Since the introduction of variousfinancial services legislation in 1994(including the Investment ServicesAct), and in particular since Maltasaccession into the EU in May 2004,Malta is emerging as an alternativedomicile for both hedge funds andhedge fund managers.

Hedge funds may not be marketed toretail investors in Malta althoughMaltas entry into the EU in May 2004means that UCITS funds (which mayhave certain hedge fund-likecharacteristics) are eligible for apassport enabling them to bemarketed in other EU member states.

Hedge funds are typically establishedas Professional Investor Funds (PIFs).It is also possible for a fundestablished overseas to transfer its

domicile to Malta and apply to beregistered as a PIF.

There are two categories of PIFswhich are available to different typesof individual investor (as well ascorporates and trusts):

1. Qualifying Investors: there arevarious criteria to be met to beclassified as a qualifying investor,however, the main criteria is thatthe investor must have more than$1 million of net assets and that

the minimum initial investment is atleast $100,000 (or equivalent inanother currency).

12 Special rules apply for unit linked insurancecontracts.


23/40


2. Experienced Investors: these aredefined as persons having theexpertise, experience andknowledge in the acquisition/disposal of funds of a similar riskprofile to which the proposed PIFin question relates. The minimuminvestment threshold is $20,000.

There are no restrictions on theinvestment powers of a PIF and theymay not use leverage.

The Malta Financial Services Authority(MFSA) has committed to processapplications for the authorisation ofPIFs within seven working days,provided all relevant documentationhas been provided and that allfunctionaries are based and regulatedin a Recognised Country.

Taxation

Distributions to non-resident investorsand capital gains made by suchinvestors on exit are exempt fromMaltese tax. A 15% final tax isimposed on distributions to Maltese-resident non-corporate investorsand capital gains made on exit byMaltese residents.

NETHERLANDS

Regulation

Foreign hedge funds can beauthorised for distribution in theNetherlands subject to the samerules as ordinary investment funds,which are required to obtain a licenceprior to being distributed beyonda restricted group or beyond agroup of professional investors.The Netherlands Authority for theFinancial Markets (AFM) will grantsuch a licence subject to certainrequirements being met. Theseinclude consideration of whether thefund is subject to adequatesupervision elsewhere. The AFM hasdetermined that currently only alimited number of countries provideadequate supervision.

An amended version of the Acton the Supervision of InvestmentInstitutions (Wet toezichtbeleggingsinstellingen - WTB) willbecome effective in July 2005.The main effects on hedge funds andtheir managers will be as follows:

1. Domestic hedge fund managerswill be required to obtain a licencefrom the AFM and may then launchnew hedge funds without thevehicles being required to obtain anindividual licence.

2. Foreign hedge fund managers mayonly obtain a licence where the

AFM has determined that homecountry supervision is adequate.

It is anticipated that the Act onFinancial Services (Wet financieledienstverlening - WFD) will becomeeffective in early October 2005.This will require providers of varioustypes of financial services to obtain alicence from the AFM. Hedge fundmanagers will not be required toobtain a second licence in additionto the one required by the amendedWTB. Legal entities and naturalpersons making offers of shares inhedge funds or providing advice to

the public on hedge funds will berequired to obtain a licence underthe WFD.

In 2003, legislation was publishedwhich subjects funds to rules ofconduct regarding conflicts ofinterest, client acceptance and

integrity. Separate rules have alsobeen introduced for certaininvestment vehicles includinghedge funds.

Taxation

Individual investors are deemed toreceive a notional yield of 4% onhedge fund investments which istaxed at the rate of 30%. Distributionsof actual income and gains arenot taxable.

Banks, insurance companies andcorporate entities are taxed onincome and capital gains from hedgefund investments at the corporatetax rate of 31.5% (2005 rate).A participation exemption may beavailable in respect of investments inEU hedge funds and funds-of-hedgefunds that exceed a shareholdingof 20%.

Capital duty will be abolished from1 January 2006.


24/40


NORWAY

Regulation

Under current regulations, foreignhedge funds may only be activelypromoted in Norway with thepermission of the Norwegian FinancialSupervision Authority (FSA). We arenot aware of any foreign hedge fundthat has been granted permission bythe FSA to be promoted in Norway.

The Ministry of Finance has issueda consultation paper proposing toallow hedge funds to be marketedto professional investors. Theconsultation period ended in April2005. Currently, the Securities FundAct prohibits the solicitation ofsubscriptions in hedge funds, fromboth individuals and legal entities.

Taxation

Individual investors will be subjectto tax at 28% on income and capitalgains on a receipts basis fromhedge fund investments structuredas corporate vehicles. From 1January 2006 a component of thereturn (3.3% of cost price) will betax exempt.

Hedge funds structured aspartnerships will be treated as taxtransparent in Norway and all classesof investors will be subject to tax onincome and gains at 28%.

Corporate investors in EEA hedge

funds structured as corporatevehicles will be exempt from tax ondividends received and gains onshares under participation exemptionrules regardless of the level of holdingor the time period for which theshares have been held. Losses willnot be tax deductible.

For corporate hedge funds outsidethe EEA, the participation exemptionfor capital gains will only apply wherethe shareholder holds 10% or more ofthe capital and voting rights of the

fund. In addition, the ParticipationExemption will not be available wherethe hedge fund is situated in a lowtax country.

PORTUGAL

Regulation

The Portuguese Stock MarketCommission (CMVM) introduced newrules in October 2003 governingSpecial Investment Funds (SIFs).Short selling, leveraging, investmentconcentration and use of derivativesare permitted in SIFs but are subjectto limits.

Fewer rules apply than with mutualfunds, but certain rules are stillapplicable to SIFs, for example, thoserelating to authorisation by the CMVMand transparency.

Portuguese hedge fund managersseeking to launch funds which do notqualify as a SIF (for example foreignfunds) need to request authorisationfrom the CMVM in order to managesuch funds.

Taxation

Individual investors into domestichedge funds are exempt from tax,unless the income is connected withcommercial, industrial, or agriculturalactivity which is taxed at marginalrates, but withholding tax up to 25%is imposed at the fund level. Capitalgains are taxed at 10%, unless gainsare connected with commercial,industrial, or agricultural activity whichare treated as taxable profits taxed atnormal rates.

Individual investors in foreignhedge funds are subject to tax atmarginal rates up to 40%, althoughdistributions by paying agents locatedin Portugal are taxed at 20%. Capitalgains are taxed at a flat rate of 10%.

Corporates, banks and insurancecompany investors in domestic hedgefunds are taxed on income andcapital gains (up to 27.5%). Incomederived from a foreign fund is treatedas taxable profit. Pension funds areexempt from tax and may reclaimwithholding tax and any tax paid by

the fund.

Foreign investors in domestic hedgefunds are taxed on capital gains.


25/40


RUSSIA

Regulation

Hedge funds products are notcurrently regulated in Russia. Hedgefund products may only be marketedby way of private placement.

A proposed new legislative frameworkfor derivatives will require majormodifications to existing legislation.

Currently, derivative transactions aretreated as gambling contracts. Thebanking sector (domestic and foreign)has prepared a concept paperdetailing its thoughts on how it wouldlike to see the legislation develop.

Taxation

Individual investors in a domestic unitinvestment fund (UIF)13 are taxed at arate of 13% on distributed incomeand capital gains. Corporate entities,banks and insurance companies are

taxed at a rate of 24% on incomedistributable by an UIF and capitalgains. Pension funds are taxed ata rate of 24% on income andcapital gains.

For foreign hedge funds, individualsare taxed on dividend income at arate of 9% (13% on other income).For corporate entities, banks andinsurance companies, dividendincome is taxed at 15% (subject todouble tax treaty relief) and otherincome at 24%. Pension funds are

taxed at 24%. Capital gains are taxedat 24%.

SPAIN

Regulation

A draft Royal Decree was issuedin 2004 laying out a frameworkfor the regulation of domesticsingle-manager hedge funds andfunds-of-hedge funds. Whilst the draftis lacking in detail, we expect thatdomestic hedge funds will beavailable to expert investors oncethe final legislation has beenimplemented.

The public marketing of foreign hedgefunds in Spain will continue to bedifficult as there have been nochanges to the restrictions on publicmarketing of non-UCITS products inSpain. The Comisin Nacional delMercado de Valores (CNMV) has acertain level of discretion overauthorising the distribution of suchfunds in Spain and is likely to refusepermission to funds domiciled incountries where local regulationis deemed to be inadequate.

Taxation

Individual investors in foreign hedgefunds are taxed on income andcapital gains at rates of 15-45%.The tax treatment of investors inforeign fund-of-hedge funds willdepend on the legal status of thevehicle and whether the fund isresident in a black listed tax havenjurisdiction.

Corporates, banks and insurancecompanies are taxed at 35% on bothincome and capital gains. Pensionfunds are not subject to tax. There aredifferent tax rules for the taxation ofinvestment in hedge funds dependingon: a) the legal status of the hedgefund; b) its fiscal residence; c) thespecific accounting guidelinesapplicable to ordinary corporations orto each type of institutional investor;d) choices the institutional investorsmay make for accounting purposes;and e) regulatory approvals formarketing in Spain.

SWEDEN

Regulations

Approval from the Swedish FinancialSupervisory Authority (FSA) isrequired prior to distributing foreignhedge funds in Sweden. Registrationtakes two months and is only grantedif certain requirements are met,including that the foreign hedge fundis subject to adequate home statesupervision.

Domestic funds are required to obtaina licence from the FSA.

Swedish funds-of-hedge funds arenow permitted to invest in foreignhedge funds and may be marketed toretail investors.

Single-manager hedge funds may bedistributed to retail investors.

Taxation

Individual investors are taxed, on areceipts basis, on income and capitalgains from hedge fund investments atthe rate of 30%.

Banks and insurance companies(non-life business) are taxed onincome and capital gains from hedgefund investments at the rate of 28%on an accruals basis (although theymay elect for a receipts basis).

Other corporate entities are taxed onincome and capital gains from hedgefund investments at the rate of 28%on a receipts basis.

13 Hedge funds are not developed in Russia. A UIF isthe most developed fund type and is notspecifically a hedge fund.


26/40


SWITZERLAND

Regulation

Future changes include new laws forCollective Investment Schemes(affecting hedge funds and hedgefund managers) which will replacecurrent regulation, perhaps as early as2007. The major changes include theintroduction of:

1. a qualified investor concept;

2. new legal forms for funds (e.g.Swiss SICAVs);

3. dual approval (i.e. products andasset managers/promoters ofSwiss collective investmentschemes would all need to beauthorised);

4. a prime broker concept (withforeign prime brokers beingacceptable); and

5. a simplified prospectus.

The proposed changes wouldeliminate the current requirement fora written contract covering the sale ofinterests in single-manager hedgefunds or funds-of-hedge funds.

Hedge fund managers are notcurrently regulated unless they arethe formal fund managementcompany (Fondsleitung) of Swissinvestment funds or a regulated bankor securities dealer, although this isexpected to change. The FederalBanking Commission is currentlyconsidering regulating hedge fundmanagers under existing rulesrelating to securities dealers as aninterim measure.

The approval process for thedistribution of EU-domiciledproducts in Switzerland is relativelystraight-forward.

Retail investors may invest in theshares of funds-of-hedge funds which

are closed-ended non-regulated listedinvestment companies. IFA-regulated

open-ended Swiss hedge funds orfunds-of-hedge funds and foreignhedge funds approved for distributionin Switzerland may be sold to retail,high net worth and institutionalclients. Hedge funds that are notapproved in this manner can be soldto high net worth and sophisticatedinvestors via private placement or inconnection with a discretionarymanagement contract but may not bepublicly marketed.

Taxation

Individual investors in domesticdistributing hedge funds are taxed ona receipts basis, with a tax refundfor any withholding tax (35%) leviedby the fund on the distribution.The applicable tax rate for individualinvestors for this income is between

25% and 55%, depending on thecanton where the individual investoris resident. Individual investors indomestic accumulating funds aretaxable on deemed incomedistributions. Capital gainsdistributed/accumulated by funds aretax exempt provided sufficientinformation is provided to Swiss taxauthorities and the investment is heldas a private asset.

Corporate, pension fund, bank andinsurance company investors in

domestic distributing funds are taxedon income and capital gainsdistributed. The average applicabletax rate is between 16% and 25%,depending on the canton where thecompany is domiciled and on apossible special tax status of thecompany. Accumulated income is notsubject to tax on an unrealised basis.Pension funds may be exempt fromincome tax if certain conditionsare satisfied.

Individual investors in a capital gain-oriented foreign fund-of-hedge funds(transparent for Swiss tax purposes

on a federal level14) that derive 98%of income from capital gains aredeemed to derive capital gains, whichare not subject to income tax.Investors in other funds-of-hedgefunds are taxed as if the investorshad a direct investment in theunderlying funds.

Income of foreign hedge funds thatare organised in non-corporate form(e.g. tax transparent) are taxed at theinvestor level15.

Any distributions from corporateforeign hedge funds, which are nottreated as transparent for Swiss taxpurposes, are treated as dividendincome in the hands of corporate andindividual investors. Corporateinvestors may be able to apply forparticipation relief if certain conditions

are satisfied.

14/15 Most of the Swiss cantons follow the conditionsof the federal law with respect to the transparenttax treatment of the fund


27/40


UNITED KINGDOM

Regulation

The UK introduced revised rules forauthorised funds in early 2004.These rules introduce two newclasses of authorised fund in additionto the existing UCITS funds. The twonew fund types are non-UCITS retailschemes, aimed at the retailconsumer and expanding the range ofeligible assets to include property andgold, and Qualified Investor Funds,aimed at institutional/expert investorswith minimal restrictions as to eligibleassets and gearing.

The revised regime for authorisedfunds, including UCITS, does permitthe use of derivatives for investmentpurposes and short selling, providingthe short is liquid and can be cashsettled or is covered by long positionswith return profile that is highlycorrelated to that of the shortposition. Restrictions on gearingmean that not all the characteristicsof a hedge fund can be fullyemployed in an authorised schemebut, nevertheless, hedge fund-likeproducts can now be promoted toretail customers.

To date, the uncertainty surroundingthe tax treatment of the new classesof authorised funds has restrictedthose seeking to utilise the newinvestment powers that these fundsoffer. Now that the tax position hasbecome clear (there will be noseparate tax regime for the two newclasses of authorised fund existingtax rules that apply to authorisedfunds will apply), it is likely that wewill see an increasing number of thesefunds seeking authorisation fromthe FSA. However, the furtherconsultation paper emanating fromthe CESR regarding Eligible Assetsfor UCITS schemes may restrict infuture the ability of the FSA toauthorise some of the more innovative

fund structures coming to the marketat present.

In parallel with the liberalisation of theauthorised fund environment, the FSAis increasing its focus upon the hedgefund industry in general. It hasannounced that a further discussionpaper will be published in the summerof 2005 where, following its review ofthe sector in general, it will againconsider the appropriateness orotherwise of permitting hedge fundsto be actively promoted.

Notwithstanding the uncertaintysurrounding the use of certaininstruments, the UK has seen theemergence of hedge fund productsand activity appears to be increasing.UCITS III funds that offer returns thattrack hedge fund indices andnon-geared long/short funds havebeen launched and there areexamples of hedge funds that arelisted on the various Londonexchanges.

Taxation

Individual investors are taxed atup to 32.5% on dividends fromnon-transparent hedge funds.Individual investors will also besubject to tax on non-dividendincome and capital gains up to 40%.

Corporates16 are subject to 30% taxon income derived from a hedge fund.

For corporate investors,the return from a foreign hedge fundmay be taxed on an annual mark-to-market basis in certain circumstances,in which case the offshore fund rules(see below) do not apply. Pensionfund investors are exempt from tax.

Open ended investment companiesand authorised unit trusts are taxed at20% on income, but are not subjectto tax on capital gains on disposal ofinvestments. Unauthorised unit trustsare taxed at 22% on income.

The HMRC has recently clarified thatqualified investor schemes and retail

non-UCITS funds will generally betaxed in the same manner asauthorised unit trusts and OIECs.

Investment in a foreign hedge fundis likely to constitute an interest in anoffshore fund. This means that UKresident investors would prefer the

foreign hedge fund to obtain UKdistributor status in order tosafeguard the tax treatment ofrealised capital gains.

HMRC has recently announced newanti-avoidance rules where aninvestor holds a substantial interestin a Qualified Investor Scheme.Further consultation on the possibleextension of the anti-avoidance rulesto investors who hold a substantialinterest in any type of authorised fundwill take place in the future.

16 Special rules apply to qualifying investments heldby life insurance companies in offshore hedge funds


28/40


USA

Regulation

Rules in the U.S. generally requireinvestment advisers to register withthe SEC if they manage the assets ofU.S. clients. There are certainexemptions from registration foradvisers which manage the assets offewer than 15 clients (or for U.S.-domiciled advisers that manage lessthan $25 million). The rules forcounting the number of clients haverecently been revised to count eachinvestor in a fund as a client ratherthan counting each fund as a client.This rule change takes effect on 1February 2006 and will require manymore advisers to register with theSEC. Advisers who have theirprincipal place of business outsidethe United States (OffshoreAdvisers) only need to count theirU.S. resident clients (determined at

the time of initial investment) towardsthis 15 client threshold.

An Offshore Adviser that is requiredto register with the SEC because itadvises 15 or more U.S.-residentclients would be subject to theSECs books and record-keepingrequirements and will be subjectto routine examination by the SEC.For the purposes of determiningwhether the Offshore Adviser issubject to certain other rules,including the compliance rule,

custody rule or proxy voting rule, theOffshore Adviser is permitted to counteach non-U.S. domiciled private fund(and not the underlying investors) asits client. If an Offshore Adviser onlyadvises non-U.S. domiciled privatefunds and has no other U.S. clients,it would generally not be subject tothese other rules.

Taxation

Domestic funds are generallystructured as fiscally transparent

entities for U.S. tax purposes.Investors in a fiscally transparent fund

are treated as earning the incomethat is derived by the fund. Also, theincome earned by a fiscallytransparent fund retains its characterat the level of the investors. Therefore,individuals, corporates, banks andinsurance companies investing in afiscally transparent foreign domiciledfund are taxed on the income(including capital gains) derived bythe fund on an accruals basisregardless of whether such incomeis distributed.

The income is taxed at graduatedrates, with the highest rate being35%. However, certain types ofqualified dividends and long-termcapital gains are taxable to theindividual investors at 5% or 15%rate depending on their incometax bracket.

When investors dispose of theirholdings in a fiscally transparent fund,capital gains may arise to the extentthat the tax base of the investors inthe fund (adjusted for the incomeallocable to the investor over the lifeof the fund and contributions anddistributions) is different from theamount realised. For non-fiscallytransparent foreign funds, there is,generally, no tax on current income orcapital gains earned by the fund withrespect to a particular investor, unlesssuch an investor makes a QEF17

election with respect to such fund.There are certain proceduralrequirements that have to be satisfiedby the fund and certain informationstatements need to be provided inorder for an investor to make a QEFelection. If a QEF election is made,the investors are taxable on anaccruals basis on the income that isearned by the fund.

If a QEF election is not made, tax is

imposed on any gain realised ondisposition of an interest in, or certain

distributions from, a non-fiscallytransparent fund. This tax is increasedby a deferred tax amount. In generalterms, the computation of thedeferred tax amount attempts tosubject a portion of the gain realisedon a distribution or sale attributable toeach year of the holding period to an

interest charge and the tax at thehighest applicable income tax rate ineffect for that year.

Pension funds are not subject totax on capital gains or incomeunless there is unrelated businesstaxable income.

17 Qualified electing fund.


29/40


OTHER TERRITORIES

BAHAMAS

Regulation

Under the Investment FundsRegulations 2003, foreign domiciledfunds wanting to establish adistribution channel in the Bahamasmust appoint a representative whomust be approved by the SecuritiesCommission of the Bahamas.

Consideration is being given toexempt investment managers thatmanage investment funds that arelicensed or registered under theInvestment Funds Act 2003 fromregis

Pwc Reg Distrib Hedge Funds05

Documents

Transcript of Pwc Reg Distrib Hedge Funds05