Funds unaware of onshore US tax breaks

Many non-US re/insurers and insurance-linked securities (ILS) funds offering collateralised solutions are unaware that tax changes in the US mean they can now base their trusts onshore and use money market funds to invest the assets—a preferable option for several reasons.

That is according to Robert Quinn, vice president and product leader for the Insurance Collateral Solutions group at Wilmington Trust. He explains that prior to this regulatory change in December 2015 non-US tax paying re/insurers and funds using an onshore US fund would be assessed a 35 percent withholding tax on dividend income generated by such a fund. This is primarily why offshore entities use offshore funds.

That has changed. Non-US taxpayers can now use an onshore fund and pay zero tax on investment gains—as long as the assets of the fund in question are invested in US government securities. Income derived from securities within the fund that are not US government-based is subject to the tax. Therefore, 100 percent treasury funds are fully exempt from withholding.

Quinn explained that the tax rules before the change meant that most offshore entities used offshore funds—and most still do for this historic reason. However, offshore funds rarely invest only in very low risk government securities (as they are ‘prime’ funds).

In addition to this, many prime funds no longer have a net asset value (NAV) of $1 per share, meaning that the value of the collateral and the value of the investments both have the potential to fluctuate.

“Many fund managers and investors do not like this; they are very risk-averse,” Quinn said. “Not having a NAV of $1 means the value of the collateral has the potential to fluctuate. People care about this issue and simply desire the safest possible investment portfolio possible.

“Offshore funds are not ideal but few people realise the onshore option that is available now.”

He noted that there are some limitations on the fund managers that can take advantage of this onshore offering.

A number of countries and domiciles are listed as not eligible by the money market fund families themselves. Most notably for the ILS community, a fund based in Guernsey cannot use an onshore US fund to invest its assets.

Quinn added that many people are unware that this opportunity is now available, although offering onshore funds to offshore clients creates the perfect combination of very safe investments in US treasuries, a favourable tax structure and a NAV of $1 for every share purchased.

“What we find is that investors in this area are doing so because they want the re/insurance risk, not the investment risk.

“By investing in a very safe way, they are probably not maximising investment returns, but as I have been told dozens of times, reinsurance and ILS investors want to sleep at night without having to worry about investment risk,” he concluded.

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