Domestic Mutual Fund Vs. Offshore Mutual Funds

Changes in U.S. tax laws make offshore investments less appealing than they were before the legislation.

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Offshore mutual funds are mutual funds with institutional management in a jurisdiction outside the United States and its territories. The reasons for investing in an offshore mutual fund rather than a domestic fund vary. The advantages, disadvantages, and even the ethics of U.S. citizens investing in these vehicles are in dispute.

Tax Advantages

Historically, U.S. citizens have invested offshore because of the tax advantages. Some of these investments were illegal, and relied on the jurisdictions -- often called tax havens -- offering the investments to collude in concealing both capital and income from the U.S. Internal Revenue Service. Many offshore mutual funds, are not illegal, and in the past have offered both legitimate tax advantages and compliance with IRS regulations. In the 21st century, the IRS has closed many of the loopholes that provided the advantages. Two particularly effective IRS strategies are the requirement that all U.S. citizens report and pay taxes on all worldwide income, and the stipulation that financial structures that exist primarily to offer a tax advantage are illegal, even if all the actions taken would otherwise be legal. U.S. investment firms offering offshore mutual funds now state that they "are available to non-U.S. citizens."

Reduced Overhead and Oversight

One considerable expense for any U.S. mutual fund is compliance with federal regulations, especially regulations of the Securities and Exchange Commission. Most large U.S.-based mutual fund organizations have compliance officers, and sometimes entire compliance divisions, overseeing fund activities. An offshore mutual fund does not have these compliance costs, and has lower overhead generally, such as lower salaries, facility expenses, and municipal taxes. This makes it possible for foreign mutual funds to charge lower management fees. The absence of SEC regulation means that shareholders in the fund have fewer protections and less oversight than shareholders in U.S. mutual funds.

Compound Profits

For non-U.S. citizens, offshore mutual funds offer the opportunity to invest companies in jurisdictions with favorable tax structures. Over time, the advantages are similar to the tax advantage of an IRA account, where untaxed profits are reinvested to achieve further untaxed profits -- the difference being that in the U.S., these taxes are only deferred, not entirely avoided. Other than the added safety of SEC oversight, there is no offsetting advantage for investors in domestic mutual funds.

Gray Areas

The complexity of U.S. tax laws, and the changes in these laws in the early 21st century to reduce tax avoidance from offshore investments, suggest that U.S. citizens and non-U.S. citizens who reside in the U.S. should consult with an independent tax attorney -- not the fund's tax advisor -- before committing to an offshore mutual fund investment.