Hedge Fund Offering Terms The terms upon which interests in a hedge fund are issued to investors define both the commercial terms upon which investors participate in investment returns and the rights of investors in respect to their investment. The nature of the interests held by an investor in a hedge fund will reflect the legal form of the fund. For example, investors in a fund established as a body corporate will generally be issued with shares in the fund and have the status of shareholder; investors in a unit trust will generally be issued with units (representing a beneficial interest) in the trust and have the status of unit holder; and investors in a limited partnership will be issued with limited partnership interests (generally representing a capital account in the name of the investor) in the limited partnership and have the status of limited partner. The precise voting and other rights granted to the investor are set out in the constitutional documents of the fund. In common with many other types of funds, investors tend to participate in hedge fund structures through multiple classes (and, in the case of a company, series within a class) so as to give effect to the different terms upon which investors participate in the fund profits. Accumulation/Distribution Policy A typical hedge fund will adopt an accumulation or “roll up” policy. In such circumstances, the fund does not seek to distribute net income or capital profits, whether by way of dividends (in the case of a fund in corporate form) or distributions (in the case of a limited partnership or unit trust). Instead, profits are retained within the fund and reinvested as part of its ongoing investment strategy. As a result, the standard approach is to issue to investors accumulation (i.e., non-distribution/ dividend paying) shares or interests. This is also consistent with the tax requirements of many types of investors, particularly those who invest in a hedge fund via a non-tax-transparent entity. Such investors may prefer not to realise a tax event until their interests in the relevant fund are redeemed/withdrawn (and thus any investment gain is realised).
There are circumstances, however, where it may be appropriate to structure the fund so as to pay distributions by way of dividend or similar arrangement. Some of these circumstances are outlined below. ^ Funding Tax Charges. Certain categories of investor can be subject to tax on the underlying income or gains of the hedge fund as they arise. This is more typical of investors in tax-transparent structures. It is usually less of an issue for investors in non-tax-transparent structures who are generally only taxed when they realise their interest in the fund; although it should be noted that certain categories of investor can still be treated as subject to tax on the underlying activities of a corporate fund. Typically, a hedge fund will permit relatively regular redemptions and investors who are taxed on a transparent basis in relation to the underlying profits and income of the fund will be able to help fund tax charges in this way. However, in circumstances where: • a hedge fund strategy is relatively illiquid and, as a result, redemptions of interests are limited or restricted; or • the hedge fund imposes long “lock up” periods on investors, during which redemptions are not permitted, it may be important to offer investors the option of receiving regular distributions and/or dividends through holding distributing interests in a fund. Often, this is linked to the net income generated by the fund’s portfolio. However, sometimes dividend and/or distribution rights are required to be extended to cover some part of the capital profits of the fund. ^ Reporting Fund Status. Under the UK’s offshore fund tax rules, any gains realised by a UK taxable individual investor on the redemption or disposal of an interest in an offshore fund will be treated as “offshore income gains” subject to income tax at up to 45% (rather than capital gains at a maximum rate of 24%) unless the relevant fund (or share class) is approved by HM Revenue & Customs as a “reporting fund.” Approval as a reporting fund requires the
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