on March 25th,
2016
Private equity funds have
become a staple of investment in every industry sector from real estate to technology
to energy to healthcare and more.
The investment success of private equity
funds has enabled growth in the overall economy and has been a saving grace to
many private and public firms who have had difficulty in obtaining growth
capital from traditional financial institutions.
Some #private_equity_funds originally based in the US have moved offshore or formed offshore
parallel or feeder funds in jurisdictions like the Cayman Islands and British
Virgin Islands (BVI) in order to attract foreign capital.
Many foreign
investors who are not U.S. citizens or U.S. resident aliens generally do not
wish to invest directly in the US as doing so could cause them to be directly
subject to US federal income tax (and potentially U.S. estate and gift taxes) with
respect to certain of their U.S. investments. In addition, a direct (or
deemed direct) investment can require compliance with certain U.S. filing
obligations including the filing of U.S. federal income tax returns. The
dual outcomes of direct US federal taxation and U.S. federal filing obligations
can be impossible obstacles for foreign investors who would otherwise want to
participate in the dynamic US economy.
As a result, private equity
funds frequently form a non-US blocker corporation targeted to foreign
investors. Such a non-US blocker generally allows foreign investors to
invest directly into that offshore fund, which in turn, invests in US
assets. The primary benefit of such a structure is that the offshore fund
can then redeploy the capital and invest directly into US assets without the
foreign investor directly being subject to US federal taxes. Moreover, it
generally can also allow such foreign investor to avoid certain applicable US
federal tax filing obligations attributable to such investments. To the
extent there are any US federal income taxes or US filing obligations, the
non-US blocker corporation, rather than the foreign investors, generally would
bear such taxes and comply with the applicable US filing obligations.
As a note, US citizens and US
resident aliens (generally those with a US green card) usually prefer to invest
directly in US assets or through entities treated as fiscally transparent for
US federal tax purposes to try to ensure one level of US federal income
tax. Ensuring only one level of US federal income tax is material since
such persons are generally already subject to US federal income tax on their
worldwide income.
Recently, Chinese investors
have begun to look at the benefits of participating in US investments through the
mechanism of private equity funds. With the success of the China economic
engine and its creation of wealth, outbound investment interest is becoming
increasingly desirable. In recent years, China has opened free trade zones, for
example in Shanghai, which has liberalized and made more flexible the ability
of Chinese companies and individuals to participate in outbound investments.
The big question is whether the Chinese government will allow the growth of
outbound investment at a time when the China economy, which has been slowing
the last few years, is in need of maintaining the capital inside China to
encourage its own growth. Add to this the fact that the currency of
China, the RMB, has been depreciating, and is expected to continue to depreciate
in value, causes concern that the Chinese government will seek to restrict
outbound investment.
Of course, this same rationale has accelerated the
desire of Chinese business and individuals to hedge the depreciating value of
their assets by converting RMBs into currencies such as the US Dollar which has
proven to be a more stable currency. In light of this, it is still possible to
establish a private equity fund in places like the Shanghai Free Trade Zone
(SFTZ) and file an application with the Management Commission of that zone to
permit outbound investment into funds established in the Cayman Islands or BVI
for purposes of then investing into US assets, commercial real estate being a
prime target. The US investment will need to be identified upfront as the SFTZ
Management Commission is unlikely to allow the aggregation of Chinese investors
into a blind pool investment vehicle.
Some funds created in these
free trade zones have had good success in getting rapid approval for making
outbound investments. Time will tell if these recent trends accelerate in
allowing greater outbound investments, but as China struggles with how to grow
its economy and grow its own middle class, opening the outbound investment
pipeline may simultaneously cause acceleration of inbound investments into
China, thus accomplishing the ultimate goal of China of building its own GDP
and expanding the wealth of the middle class of China. These are complex
structures requiring multi-disciplinary expertise, competent legal advisors,
and appropriate fund administration.
Circumstances being what they
are, the potential for migration agents who have had great success in raising
capital for the EB-5 sector to greatly expand their ability to offer new
products to its client base while providing significant benefits to Chinese
investors (outside EB-5 investment) has never been better. The formation of
funds that would allow outside investment is a great opportunity for migration
agents and should be seriously considered.
For
additional information, please read more about Greenberg Traurig’s
Private Equity Practice or contact Bruce C. Rosetto.
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