If you are raising a fund in the U.S. with foreign investors, you want to be on the lookout for frequently used offshore tax evasion schemes. 

“Round-tripping” is a form of offshore tax evasion by which money earned in the U.S. moves outside the country - usually to visit a tax haven nation, such as the British Virgin Islands or the Cayman Islands. This money is then invested back to the U.S. As the name suggests, the funds make a round trip! The amount invested annually in the U.S. through “round-tripping” is estimated to be between $34 billion and $109 billion.

Let’s explore some of the key concepts of “round-tripping” equity investment and how it affects you as a fund manager.

What is the purpose of “round-tripping” U.S. equity investment?

Investors use “round-tripping” to hide funds and evade ordinary and capital gain tax rates applicable to their securities investments. In order to do so, the investment is disguised as a foreign investment. This allows returns to be taxed as a foreign investment, which has a more favorable tax treatment than a domestic investment. Further, sending funds to a tax haven nation allows for the lowest tax liability.

What is the difference between tax evasion and tax avoidance?

“Round-tripping” is difficult to detect. Because of this, governments have international tax exchange agreements to prevent tax evasion, and investments coming from tax haven nations are under more scrutiny than others.

However, there may be legitimate reasons to channel investments through vehicles located in a tax haven. For example, it could occur for regulatory or tax avoidance when investing along a foreign trading partner.

Investors must distinguish between tax evasion and tax avoidance. While both may be deliberate, only tax evasion is criminal. The main characteristic of tax evasion is the illegal nature of the scheme chosen to hide funds from the IRS. Tax avoidance is done through reading the law in the most favorable way to reduce tax liabilities (e.g. claiming tax deductions or credits).

When in doubt, it is better to consult with a tax advisor or avoid getting into tax haven territories.

What are guidelines for fund managers?

So, as a fund manager, what can you do to ensure your fund stays in compliance? 

The IRS can come to you to request information about investors suspected of engaging in criminal activities, so you want to be prepared. Failure to comply can lead to civil and criminal liabilities. That said, “round-tripping” is difficult to detect, so the best you can do is to hold yourself to the highest professional standards of fund management by following guidelines:

• Run your investors KYC

• Maintain complete and accurate records of all investments and investors

• Ensure that your investment agreements include standard language about the origin of the funds

• Report suspicious offshore tax evasion activities to the IRS

• Consult with an international tax advisor or avoid getting into tax haven territories if you don’t fully understand the legal complexities and liabilities at stakes

Working with a provider like Sydecar can help you stay on top of compliance matters, as the platform will handle KYC, keep investment records accurate, and provide standard investment agreements that include language about the origin of funds. This will significantly reduce the amount of work you have to spend on compliance and free you to focus on running your fund.