Offshore Capital Concerns – A Tactical Guide
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This webinar is focused on presenting the issues with raising money from offshore investors including legal and tax issues. The hosts discuss common approaches including feeder funds, blockers, REITs, and the portfolio interest exemption. If you are a private lender or real estate investment group raising money from investors from overseas, this webinar will discuss the core tactics to resolve the biggest issues that come from raising money overseas.
Jennifer Young: We're going to get started on this webinar. Today we're going to be discussing the hidden gems of offshore capital concerns and how to tackle a lot of issues that may arise when you're raising capital from offshore investors. So it's going to be a fun ride, and I hope you guys are all excited to join us and we're happy to have you guys. Today the webinar is going to be moderated by me, Jennifer Young. I am a corporate and securities attorney. I'm on Kevin Kim's team. Kevin is a partner here at Geraci, and he will be our guest speaker and we are so excited to hear from him and see what he has for us about all of these matters that we're going to be discussing. So Kevin, please say hi and give a little intro to those who don't know you
Kevin Kim: Hey guys. Kevin Kim here, partner here at Geraci, expert at mortgage fund formation for private lending. And we've done a good amount of this in the past few years now, but lately, especially a very popular topic. So one had to do a webinar to talk about all the little problems that come with raising money from investors who don't live here in the United States to solve these problems with your funds. So that's what we're talking about today.
Jennifer Young: All Right, so let's get started. Let us start with some key issues that arise. Kevin, can you start us off with some tax issues. That people need to think about?
Kevin Kim: Yeah. Raising money offshore primarily has to do with tax, right? So the SEC has very little concern with investors don't live here in the United States or transactions that happen overseas because they can't regulate that it's outside the jurisdiction. So there are some compliance matters to think about from a securities law standpoint, but primarily that just revolves around regulation S the big issues that come up with raising money offshore are tax, and the big two ones are first active trader business. And so your debt fund and your lending business is considered an active trader business in the United States and the state that you're in. And so unfortunately, we can't get around the argument that we're purely passive like our friends in real estate. So that creates a tax obligation when it comes to offshore investors in the form of having to file an actual return here in the United States because they've earned income here in the United States for an active trader business.
They own or have invested into an active trader business. And so the concept is called effective connected income. Want to call it ECI throughout the panel today. And the result of this is having to file a return here in the United States, which very unpopular with your offshore investors. And the second issue that comes up is the withholding of income tax because they're not a taxpayer. So these folks are not US taxpayers and Uncle Sam wants his money. And so how do we deal with that? Well, in real estate and debt funds, there's a rule that you have to do automatic withholding if you've got an offshore investor, non-US person as the fund of tax code invested in your irregular debt fund, and that results in a withholding, and that usually amounts to about 37% withholding if you're in a reit, 30% withholding on their distributions, meaning you have to withhold that before you pay them because they're not a US taxpayer and they're paying taxes in the United States. And this is how Uncle Sam gets his pound of flesh from every single one of us. This is also very unpopular with investors because many offshore investors are not from countries that have such a high tax bill, but also they may have to pay taxes at home. So this becomes two challenges we're trying to overcome in our daily lives when we're talking about fund managers in mortgage or in real estate trying to raise money from non-US persons.
Jennifer Young: Great, thanks. And then really quickly, let's discuss the AML/KYC concerns that a lot of fund managers have questions about.
Kevin Kim: Yeah, I mean AML/KYC for those who are uninitiated, AML stands for anti-money laundering and KYC stands for know your customer. These are things that you're probably used to dealing with on the lending side of your business. You're vetting your borrowers, you're making sure that they're real people. They're not laundering money, they're not committing fraud, they're not committing mortgage fraud or money laundering, but that's the same logic that applies when you're raising money, right? As fiduciaries, we are obliged to comply with AML/KYC obligations, and this gets enhanced when we're raising money offshore, especially from certain parts of the world where there's very little oversight into the financial institutions that exist. And so the biggest issue you come into, and from a money laundering standpoint, source of funds issues, and this gets exacerbated by each country's having their local remittance restrictions. For example, country of China has significant restrictions on outbound capital from their country. They want to keep the cash in the country, and so investors get creative, but that creativity raises a lot of red flags. And the simplest creative idea, the structuring of having your cousin, your mom, your aunt, your brother, wire money into your account, well, that's a problem, right? Because it's source of funds issue and you also have identification issues. What was that?
Jennifer Young: Yeah, sorry about that. Identification issues. How do you deal with that and source of funds, what do you look for document wise?
Kevin Kim: If you see that happening, that's a red flag. Tell the investor to stop. That's not something you can accept. So funds need to be coming from a particular source in that person's name or that company's name, or that has to be coming from a consistent source. So if the wire is coming from their own local account, let's say in China to them, and the common methodology with China is the money's already in Singapore or in Hong Kong, well then the accounts needs to be consistently owned named. You can't have money being flowing from different accounts. And there's some best practices here, but a lot of times clients, what I tell clients is think of it as simply as this. If the source of funds in a different name, right? If Joe Smith is investing into your fund and Joe Smith's source of funds from overseas is not in his known name, you've got a money laundering problem, simple.
Beyond that, there's other issues when it comes to source of funds, particularly when it comes to, I guess you can call it creative means of getting funds over through different remittance programs. So a lot of folks have been using cryptocurrency, stable coin and things like that. There's a lot of risk there unless managed through a properly regulated channel, you run the risk on your side of being sucked into these investigations. So that's the problem. All this, right? Not only do we have an obligation to do the investigation and do the actual due diligence on the investor sourcing, but we also have to think about, well, what if we skip something? What's the risk to us? And so the regulatory body that governs AML/KYC is the office of the Treasury and FinCEN, and they've been known to, I guess you can flag these issues, and then you have to deal with subpoena actions, subpoena power, defending your cases, paying for legal fees to do that.
On top of that, you may also be sucked into any kind of criminal investigation that you may just took money from an investor with whom you didn't do a basic homework check on. So that's the other part of this is the identification part of making sure you know who you're dealing with. Because the problem with overseas is that we may be dealing with a country where we don't know exactly what their regulatory framework looks like, what their law enforcement framework looks like. We also be dealing with a country where no one's actually from that country. So for example, Dubai, most people that you deal with who come from Dubai aren't from originally from, they're not originally from Dubai, they're not Emiratis, they're India, they're from Saudi Arabia, they're from other parts of the world, and these are parts of the world that may have sanctions. They may have black box into understanding who we're dealing with.
And so getting a passport may not be sufficient. So going through the necessary steps to protect oneself to ensure that you're dealing with someone that is not someone that's either submit the sanctions by OFAC or under investigation, or there's a warrant by Interpol or someone that's the sanctions by other parts of the US government or from a country that's banned from transacting with the United States. There are countries like that. So you have to watch out for that because the last thing you want is to step on that kind of landmine and all of a sudden be dealing with Vincent or ofac. So very easy stuff to manage though, right? It's very easy to run these things. Best practices on the banking side, consistent source of funds and sourcing and naming. But also on the identification side, your basic searches on most global KYC platforms will include all the necessary databases, right? Ofac, Interpol, the European version of that, the Asian version of that. You can run these database searches nowadays through third party KYC platforms. So that's definitely what you want to follow.
Jennifer Young: And these sources are all online.
Kevin Kim: Lot of them are online nowadays. There are a lot of vendors nowadays. I recommend clients look into third party providers that you can interact with and hire to be a KYC A M L provider. Also. A lot of nowadays, a lot of clients use third party fund administration. They have an AML/KYC division in their group that can help you navigate these waters.
Jennifer Young: Okay, very good. Before we move on, for some of you who joined us late, we're going to be having questions and answer session towards the end, but if you have any questions in the meantime, please direct 'em in the q and a box. The chat is not something we'll be monitoring. So there's a separate q and a toggle at the bottom of your zoom screen. If you have questions, feel free to send them there and we'll review them at the end. Thanks. Alright, so moving on, let's get into ECI. You touched a little bit about ECI and how it gets triggered and some considerations to take into account. Can you elaborate on some of the business activities and how we should think about when that really comes into play?
Kevin Kim: Yeah, so I always tell people if you are an actual private lending outfit here in the United States, ECI is a real concern. It always is, right? Your business is to actively originate and fund mortgages and origination is the key part. Whereas other folks who maybe our audience may have heard of offshore pension plans that buy mortgages or your average high net worth investor who's from overseas, that happens to lend occasionally into the United States. That is not ECI. So the active hitter business component is you have an actual origination business here in the United States where you're dealing with borrowers, you're quoting rates, you're finding the mortgages, and you're doing that piece of the business. And that's considered an active trader business. And from an I R S standpoint, debt funds are always defaulted to be treated as active trader businesses unless there's mitigating circumstances, like all they do is buy mortgages.
And even in that circumstance, it's tough to argue that. So we always revert to the idea that you are a US lending operation. You are going to be considered to have ECI. So we have to block that issue or solve that issue for your offshore investors if you plan to go in that direction. And so the solution unfortunately is not that pretty, right? The solution to mitigate ECI altogether is either one a C corp or two try to move the entire outfit overseas. So we're not going to talk about that because moving the outfit overseas doesn't really work for a lot of our clients. It's almost an impossibility for most of our businesses. So the idea of a C corporation on its face, a C corporation is not considered an active trader business by virtue of the tax arrangement that it has, and it will block it for its shareholders.
So that's why you see a lot of debt funds out there go in the redirection because the REITs automatically will block the ECI because REITs are taxed as C corporations and the other structures help out later today will also solve that problem as well. So this is the best way to mitigate it. Otherwise the solution has been, don't necessarily originate in the United States, right? Don't be actively originating in the united or investing in a business that actively originates. So there are some solutions in the context of if I buy loans actively from a US originator with sufficient what's called seasoning, that will also mitigate the idea of active trader business in the United States. But that seasoning requires a little bit of time for the lender to hold the loans on its books, and that can cause some stress, some duration and balance sheet stress for the originator. And so that doesn't always work when we're adding an offshore component to an active debt fund that has an origination or retail channel to it that's originating its own loans as compared to, let's just say like an institutional investor, an aggregator that is set up to just buy loans. That's a lot easier to do when it comes to this particular issue.
Jennifer Young: And how long would seasoning usually require
Kevin Kim: A large swath of best practices that a lot of different CPS differ on? I've heard it as short as two days heard, as long as I heard it, as long as a month. I think the general consensus these days is about a week or two weeks on hold, and that's enough. But that's a question from the C, your C P A firm and us to discuss, because I've heard CPAs go all over the map on this, right? And there's also, beyond just the seasoned part, how do you effectively sell it? Some CPAs are more conservative than others in the interpretation of the tax code, and they say, we want you to be actively selling this in the country. It's going to mean that we have to go there and actively execute the contract. But that doesn't make any sense in today's day and age with Zoom and international execution capabilities. So this has been a discussion point for a lot of people from a compliance standpoint, my recommendation is for clients to use at least within at least one to two week window, be conservative, two days is probably not going to be enough, and making sure that you have the necessary signatures done and it's happening overseas and the assignments are happening into overseas, but you don't have to actually be there. I think the being there is a little bit too conservative in my mind. Okay.
Jennifer Young: All right. So the second issue tax related was about withholding. And I know that this was a very common question or a slew of questions that we always get about withholding and the 37% withholding.
Kevin Kim: Unfortunately, withholding is the big reason why we get involved. So a lot of clients, if they come to us and say they've got a handful of investors, but they don't care about the recording, they're withholding because there's arrangements that the investor has made for themselves, and we'll get there in a second. But the investor himself doesn't care about the withholding. So they don't care about the withholding. And that's a very rare circumstance. Whenever we're going to do a serious capital raise overseas, we know we're going to raise a lot of money overseas. We have to solve this problem because if we can't solve it for the entire group of investors, then they have to solve it for themselves. Ultimately, withholding basically means, I talking about earlier, the government, the US government, their I r s wants their income taxes and the us the global reporting
Jennifer Young: Program.
Kevin Kim: So they require Kevin Kim, who makes any money in my parents' home country, South Korea, I have to report that income to the United States. If I make money anywhere in the world, I have to report that to the United States. So the US government is very aggressive in the idea of I want my money, I want my tax income. The problem is if Kevin Kim, the foreign investor, does not live in the United States and have no reason to file a return in the United States, there's no way for the US government to capture that if it is just based on an investment. So what they've done is say, alright, the investor side, the sponsor side has to withhold the income for the investor. And so that ranges depending on the strategy. So if they're a debt fund, regular debt fund, I believe the withholding, I'm not a tax attorney, but I believe the withholding is 37%.
If you're a, it goes down to 30%. And then there are these tax programs that exist under tax treaties between the United States and the counterparty country where that withholding might come down. And that withholding varies. So if it's just a regular investment versus a reinvestment, the withholding is different and that's not the only consideration to be had. Right? There's also the concept of double taxation. If you do withholding here, does that mean I don't have to pay taxes at home? Every country has different tax treaties. So you have to do a country by country analysis, which is also very challenging for a sponsor to think through because if they're going offshore to raise some serious money, they want to have a more institutionalized framework that allows 'em to raise money from multiple countries at once without having to consider all the tax treaties in each home country.
And so unfortunately, even with the eu, there's no EU tax treaty. It's country specific. And on the withholding side, same with any Asian country, it's going to be a specific country by country treaty and you have to analyze it. And that's becomes remarkably inefficient. A lot of our clients also have these situations where one or two investors come their way and we advise them to the tax issue, which we just talked about, and then we got to solve the problem for the one-off of two off investor. But then that's when we do look at tax treaties that may solve the problem. But from a, I guess you can call it more internally institutionalized strategy, you can't go country by country because you may be raising money from five countries, 10 countries, and it's just not worth the lift. But also finally, it will not eliminate the withholding altogether.
It will just likely reduce it. And then the chances are that the taxes on that side at the home country may still be there. So let's just say for example, your home country's corporate tax rate is 25%. You did a 30% withholding over here and there's no double taxation blocker on the treaty. Your investors is really paying 50 something percent, right? So not really worth it for them to consider. So that's why whenever any of our clients goes through the process, I want to raise money overseas. Seriously, we have to solve this problem. This is the bigger one, because we can solve ECI pretty easily, but this withholding issue is a problem for a lot of our clients.
Jennifer Young: I see. Well, there is a way to eliminate this. I understand. And I'm going to pull up this.
Kevin Kim: Yes,
Jennifer Young: Let us talk about the solution here. Portfolio interest Exemption. So the
Kevin Kim: Most popular strategy that's out there is the utilization of what's called the portfolio interest exemption. Because we are in mortgage, we are in real estate, we are used to lending, we're used to debt. So this is the one model that works very well. There's another structure called season and sell that we'll talk about in a second. It's less complicated. The portfolio interest exemption was created years and years and years ago. It's a means to get foreign capital into the United States as a means to attract offshore investors to lend into the United States. So the key feature of portfolio interest is that it must be based on debt. It has to be a loan. It cannot be an equity investment, it can't be ownership, it can't be stock, it has to be a loan. And then not only that, but has to qualify on the parameters of the program.
Now, this isn't everything, this isn't comprehensive, but these are the big ones that we have to make sure we meet. The first key is the lender cannot be a US person as the form of a tax code. So obviously if they're a green card holder, they're probably going to be considered a US person on the tax code because they actually spend enough time here. But I've seen fact patterns where even a green cardholder may not be considered, but this has nothing to do with immigration, right? It's everything to do with how you are viewed by the I R S when it comes to your status as a US person. So they have to be a non-US person. So meaning they have to be a truly offshore person. They don't pay taxes here in the United States. They don't live here in the United States, and they're making a loan to a US borrower with whom they have no common ownership or family relationship with.
And the goal there was because they don't want people to get cute with the program. So they don't want cousin ba, my brother lending to me and me not paying and my brother not paying taxes on it. They don't want that happening. They don't want, we call foreign control companies being set up to lend back to their own parent company and screw all that up too. So that's what things that cause problems. But also they can't be a bank. They can't be a bank, it can't be a financial institution. The interest income, the interest payments, they can't be contingent on anything and they can't be conditional. Now there has been guidance by the I R S, they index based, if you're thinking about doing A L I O R also, they can be tied to a certain event. They just can't be tied to certain they can be, can't be conditional on certain things occurring. It's very narrow circumstances that allow for it. So be very cautious there.
Jennifer Young: Example of that.
Kevin Kim: So one of the things that they do is based on the property value, they don't allow that
Contingent on the sale of the property. They can't allow that contingent on certain sale numbers occurring. They can't allow that. It has to be a true debt instrument. Those things look like a little funky. And then you have the instrument must be what's called in registered form or non-transferable. And this is less concerning nowadays because registered form can be solved by simply creating a ledger. So this is less problematic as well. But at the same time, there are a lot of restrictions here. So you have to be very cautious. You can't just say any debt instrument, any loan is going to qualify. And so this is one solution that we used on its face by itself when raising money in smaller structures. So when clients start out, a lot of our clients in private lending will start out simply either selling or brokering out whole loans to people. And sometimes they happen to be offshore people. And that will oftentimes work if a whole loan, if a person lends into the United States, but it's a whole mortgage to a US borrower, that'll work actually in most circumstances provided that the loan itself qualifies. Same with note on no programs, no on no programs that exist to raise money.
These, I guess call ation programs that exist. And also these secured or unsecured debt instruments that exist outside the securitization market also work. It's also why these bonds are quite popular to offshore pension funds. And then also the problem with that is that it doesn't always, these debt programs when you're doing it, when raising money for high net worth investors or family office money, they don't always jive with a business because we want to be able to maximize the business and solve a lot of other problems that are more, I guess bigger problems for the lender. And that has to do with solving the cash drag problem. When you have debt on the books to investors, a banker who's a warehouse line of credit provider may not love it because it looks
Jennifer Young: Like
Kevin Kim: Competing debt to them. They want to be in first position. So that creates problems for your lender finance provider. So that's why it doesn't always jive with debt funds.
Jennifer Young: Okay, understood. So what does work for debt funds? Well,
Kevin Kim: I would say it would very much depend on the client's goal. So if the client wants to go serious in raising money overseas, they really want to do it right. They want to be able to raise money from multiple countries, multiple sources, and they want to have it systematically built for a long-term use as opposed to a one-off scenario where it's just one or two guys coming in. Then my recommendation is to use the offshore feeder combined with the leverage Blocker Corporation or L L C. And this solves a lot of the problems. So let's just fictionally decide that we've got this LP G P debt fund we always put together for clients.
What we'll do is we'll create another fund overseas. We'll create either in some tax haven country, we'll go to B V I, we'll go to Grand Cayman, we'll go to Ireland, we'll go to Luxembourg, we'll go to Seychelles, whatever country the client prefers. We tend to prefer B V I Cayman just because of operational integrity and efficiency. We have good vendors there and a lot of our vendors who are fund administrators are used to working in those countries. We'll go there, we'll build the feeder fund with local council and we'll set it up in a way where the investment is actually a dead investment into a Delaware blocker, which will block the ECI and that Delaware blocker will be an LP in the fund. And then once the fund makes its distributions, the blocker court will stop B E C I. So there's no tax filing requirement on behalf of the feeder fund, but the blocker will make interest payments via the debt instrument to the B V I feeder fund or the Cayman feeder fund.
We have the debt arrangement which will qualify on a portfolio interest and then distribute that out to the investors. On the offshore side. This also works very well for non-taxable investors because it eliminates all the U B T I concerns as well. But that's also what a REIT will do. This structure is no different than what we call a master feeder structure. It is a little bit different than what we see in the equities world because the debt fund is the actual master and the offshore is the feeder. But by combination of using a debt instrument and a blocker corporation, we've created this perfect framework where we no longer have withholding, we no no longer have ECI, and we have an entity in a country that offshore investors are accustomed to investing in, if not preferred to invest in. And a lot of clients will ask me, well, why Cayman?
Why B V I? Why these offshore? Well, I'll just do it in the United States. And my answer to that is it's not really up to us. It's usually up to them. There seem to be some tax reporting blocks when it comes to certain countries like this. Every country is like the United States where you have to report all of your global income. And that seems to be a driving factor as to why they choose these tax haven countries. Theoretically, this program, this feeder master structure can be done domestically. We could do it all in Delaware if we wanted to, but it's just not that popular because of the tax reporting issues that come from the United States. So that's the primary reason we go to Cayman or Delaware or B V I. So
Jennifer Young: The Delaware part, that would be the C corp that could be formed in Delaware or which part was in Delaware?
Kevin Kim: Good question. So the Blocker Corporation is formed in Delaware, right? It's either a corporation or L L C chosen to be tax, of course C corporation, and that acts as the intermediary. And so that's the actual LP in the fund. And that thing, that entity, that corporation will borrow money from the B V I fund overseas and will also, the B V I fund will have a small equity placement as a shareholder into it. So it's a combination of debt and equity into the Delaware Blocker Corporation. And this thing is called a leverage blocker because it got leverage on its books. It borrows money from the B V I fund, and that's the primary investment. We choose Delaware primarily because of the local tax and local and the institutionalization of Delaware and all that.
Jennifer Young: Okay. Yeah, it is definitely a very convoluted structure, and each entity that's formed for purposes of this feeder structure does have its own purpose. Correct. So for the feeder, the offshore feeder, that's where the investors' funds are going and that purchases and provides debt to the Blocker Corp,
Kevin Kim: Correct? Correct. So the offshore vehicle is where the investors will come in as LPs. So it'll be a single purpose Cayman Limited or P V I limited partnership that'll be registered as a fund under their local rules.
And those LPs will, it's almost like investing in the fund because it'll mirror it from an economic standpoint, but it'll go through this convoluted structure to ensure that we solved the two problems, which is going to be the portfolio interest problem, a cheap portfolio interest treatment and second block active trader business via the Delaware blocker. So think of it like this. So the theater fund will make a loan to the Delaware blocker. It'll also be a shareholder in the Delaware blocker combination debt and equity. The Delaware blocker will then invest as an LP in the major primary debt fund. When the primary debt fund spins out distributions to the Delaware blocker. The Delaware blocker will hopefully be making all of its payments in the form of interest payments to the offshore feeder fund, the
Jennifer Young: Feeder.
Kevin Kim: And that by virtue of being by interest payments, that will solve the withholding problem on most of the income, if not all of it. And if it doesn't, then we have the remaining equity and the equity can make a dividend to the B V I feeder. We try to minimize the equity placement on in the Delaware blocker as much as humanly possible because of course it's a C corporations we're taxed the corporate tax rate. We also have double taxation. So we want to mitigate that as much as possible. So hopefully the debt will outweigh the equity. And the ratio there is not really dictated by me. It's usually an 80 20 ratio, 80 debt, 20 equity. I was
Jennifer Young: Going to ask
Kevin Kim: About that. But that's dictated by the CPAs. The CPAs will have to do a analysis to figure out what the appropriate ratio is going to be.
Have you seen typically, is it 80 debt and 20 equity or 80 debt, 20 equity? I think the most extreme is 90 10 equity. Okay. Yeah. Okay. Alright. So that sounded, that was interesting and fun. It's complicated.
Kevin Kim: It's not easy. Yeah, Yeah. It's easy. It's definitely
Jennifer Young: Complicated. Well, about, I mean now you have offshore, an offshore feeder fund, obviously you'll need offshore documents offshore, whichever country that you choose to set up this feeder fund in. Aren't there a lot of outside council, offshore council
Kevin Kim: Tax
Jennifer Young: Accounting You have to think about. So let's talk about doing these projects. So let's just say you've got an existing debt fund. So this happens to us all the time. A client comes with an existing debt fund and they want to add this. They've gotten some inroads overseas
Kevin Kim: That they've got a serious opportunity to go over and raise some money. So first things first is we're going to, if they don't already work with a experienced tax c p A group, we're going to introduce them to one and we're going to work on the structure and we're first things first. They have to understand the structure and make sure it works for them because not only does the structure have legal concerns as our primary concern, it has tax impacts because the C corp has a little bit of a tax bill, and there's also the cost of doing it, but there's also the transfer pricing component where you have to make sure that you're doing things correctly under US tax law. So we want to have the CPAs involved very early to get the framework blessed and the framework understood to the client from a tax planning perspective.
Then we also have to engage local council in the tax haven country. So then Cayman or B V I, and we work with a group that mitigates the load on the client because what they do is we handle all the drafting. They take it and they effectively will canonize it, add all the necessary disclosures and send it back to us for edit, get it cleaned up, and they'll handle all the paperwork when it comes to forming the entity, registering it with the local registration, with the local government, and all the necessary paperwork on that side. So that's their role and responsibility. On our end, we're also structuring the debt program between the Blocker Corp and the feeder fund. And that debt program has to be blessed by the C P A firm. So you also, that C P A firm needs to have an understanding of international to be able to do this.
So if you're dealing with your average local C P A, they're probably not equipped for this. You want to work with a CPA that has a lot of experience working with funds, specifically that funds, and then will basically work on a writeup that will lay out the structure. But once again, this will reliably solve your problems going overseas and raising money and also while maintaining an LP G P flavor that everyone wants to see. But once again, this isn't the only solution. There's a lot of solutions on the table. We work with a lot of sponsors that are smaller that say, Hey, this is too much for us. We don't want to put this single bill. We don't have enough opportunity overseas. Before we get into the actual alternatives here, I want to talk really quick about season and sell. So one thing that a lot of our clients don't think about is using season and sell, if you can figure out a way to work with an offshore investor or a group of investors to just sell loans to them, and you follow season and sell, meaning that you handle the origination, you season in on your books to say for what two weeks you sell to an offshore investor, and same way you'd sell to any investor that will also work under the tax programs to avoid ECI withholding all that fun stuff.
The problem with that program is that you create balance sheet duration risk on the originator. So there are programs that have been created where we add on a line of credit to solve the problem. It doesn't solve the problem, I guess in more of an institutionalized format, but it will solve a client's needs if they don't want to pursue an LP G P offshore structuring arrangement. So there are other ways to achieve this, primarily using debt as our means to get there. I
Jennifer Young: See. Alright. All right. Are you ready to talk through some alternatives in case the master feeder fund is a little bit much?
Kevin Kim: Yeah, let's do it.
Jennifer Young: Okay. Alright. So there are a couple of alternative options and REIT is probably one of the more popular ones. Maybe we can start with REITs and how they help with ECI and withholdings. Yeah,
Kevin Kim: Yeah, yeah. I don't really say that REITs, the end all be all to this, but REITs actually present an interesting solution because a lot of our clients have already gone this direction. And so the read itself is a C corp taxed as a C corp. And so the read itself blocks ECI I. So you've solved that problem by itself. So what we do, then we have a problem withholding, how do we solve the withholding problem? Well, it doesn't solve it on its face. So what we've done in the past is we've had clients use their read as a blocker and create the feeder fund that way. So we mitigate one extra step, but it's still a little clunky and some clients don't want to deal with it. The other thing, and a lot of times the clients are dealing with the one-off situations where we've got a handful of investors from a certain country.
Well then what we do is we look at the tax treaties that exist, and REIT dividends are subject to a lot of really beneficial tax treaties where sometimes the investors have very little withholding and no double taxation. So it's very, very attractive. Certain countries like China where 10% withholding, no double taxation, it's very, very attractive. And not every country's like that. Some countries just straight 30. And so it depends on the country of origin, I think about whether or not you have the withholding reduced. But oftentimes it does reduce it a lot. So you have to do that analysis, especially if you're doing a one-off situation. And obviously countries that are more, I guess larger in size have a larger and a larger, I guess tax arrangement with the United States have a better withholding arrangement. So for example, talking about China earlier, China has a 10% withholding for REIT dividends for individuals, but also Mexico is 10% withholding for individuals and entities for REITs. So it's not bad. So it's not the best, we're not eliminating withholding altogether, but it's not bad either, and you need to verify whether that tax treaty also has an anti double taxation arrangement. So ultimately then if your investors from Mexico, he's really only paying 10%, but other countries are not as beneficial. So a lot of European countries are still a fixed 30, and then other countries don't have
Jennifer Young: One.
Kevin Kim: So we've got this request a lot. What about investors from Taiwan? And I don't think there is one with Taiwan of the political situation we have with Taiwan, same with a lot of countries in South America, you don't have as many tax treaties. A lot of clients, the number one country we get in South America requests on is Argentina. For some reason there's no tax treat with Argentina that reduces the withholding. So it's a straight 30%. So that's the analysis. So it really is only beneficial when you've got a localized analysis that you're doing and you happen to already be a reit and that actually works in your favor.
Jennifer Young: What about the other couple of alternatives that we have on the screen debt Instructions? Yeah, so
Kevin Kim: The simplest way, of course is to go debt. And so you can structure an offering using Reg S and raising money overseas and offering just dead instruments. And as long as they qualify under the portfolio interest program, it will work. And this is not anything novel. We see this all the time with institutional bond raises. You see them doing the same thing. And as long as that instrument conforms with the portfolio interest program and the lender and investors really an offshore person, it will fit and
Jennifer Young: The
Kevin Kim: Sponsor can pay the full note rate and not have to deal withholding. However, the reality of that is that that investor may have a tax bill back home, which is also why Cayman becomes more popular. My understanding is that a lot of investors like the feeder model because for those their home countries, they can treat Cayman as a tax haven for themselves.
Jennifer Young: Well, for debt also, it's harder to get lines of credit, right? Banks don't usually want to see Debt.
Kevin Kim: Correct? Correct. So unsecured secure doesn't really matter. If you've got debt on your books and you want to solve the age old cash management problem, warehouse line of credit is the best solution. Well, most of the banks we work with, they're just not going to get around this roadblock for themselves. They have a strict, strict, no other leverage on the particular entity. Spvs might mitigate it, but they just don't. I don't know many banks or lender finance programs that are comfortable with these bond offerings to investors. Yeah.
Jennifer Young: Okay. And tax treaties we touched on depending on the Country, yeah, we talk about tax,
Kevin Kim: But once again, tax trees only really work if you're willing to do the lift and go through country by country.
Jennifer Young: Yeah. Are you often asked to give an analysis for certain countries? Is that something you are familiar with?
Kevin Kim: So what we'll do typically is we'll get on a call with their C P A firm, we'll use our tables, they'll use their tables, and we'll go through it. We're very well versed on the reach side, but we don't have a full on table for every single country in the world. So that's also important to think through where this is coming from is a really material issue.
Jennifer Young: You mentioned Reg S a couple of times throughout the presentation. Can you explain what that is and how that applies to these debt funds?
Kevin Kim: Yeah, yeah. So regulation SS is the federal safe harbor for offshore capital raising. So it's the exemption that you use if you know you're going to go out and raise money overseas. And what you do is you can do it simultaneously with that Reg D. So it's not like you have any additional huge lift on your end. The issue with Reg as is that it has to happen overseas and it has to stay overseas. So I always tell clients,
Jennifer Young: You mean the investor,
Kevin Kim: Right? Or the Entities. The transaction has to be happening overseas. I mean, the investor has to really be overseas. They can't be here in the United States and the transaction has to stay over there. I mean that they can't bring this investment into the United States. So that causes some additional compliance concerns. So we always tell clients who are your average Reg D debt fund? So if you're going to do Reg S in conjunction, you should still kind of be using Reg D's terms as the guiding factor, the compliance, the qualification terms as the guiding light, even though Reg S doesn't have the same regulatory requirements because there's a possibility that an investor might come here to the United States.
Jennifer Young: So what are the regulatory requirements for Reg S offerings? Not
Kevin Kim: Much really. I mean, there are some filing requirements if you're doing in conjunction with the 1 44, but in conjunction with a D, you don't really need to file anything. There's no investor eligibility requirements either. The key issue is that it's happening overseas. Everything has to happen overseas and you have to conform a local law. Obviously that's also another key requirement. And then also the transaction, the asset that's been purchased, the security that's been purchased cannot come back to the United States. What does that mean? Cannot not
Jennifer Young: Come back.
Kevin Kim: Gabby's traded to a US person. So resold to a US person, that cannot happen. It has to stay overseas.
Jennifer Young: And so there's no
Kevin Kim: Requirements. Basically they have to keep their money invested until they redeem effectively.
Jennifer Young: I see. So there's no requirements for them to be an accredited investor. Theoretical, technically speaking, regulation S does not have that requirement,
Kevin Kim: But I always advise clients, if you've got a Reg D in conjunction with a Reg S, you should require it regardless because the last thing you want is, oh, this guy no longer lives in Seoul, South Korea. He now happens to be living in Los Angeles. I didn't know about it and now I'm not requiring him to be. So it's not worth the risk. And also frankly, it'll also help you in your amm L K yc because you're doing the Reg D part, right?
Jennifer Young: Yeah. Okay. So best practice it sounds like is to conform with the Reg D exemption.
Kevin Kim: I recommend it some clients to push back on the issue, but just for peace of mind's sake. And also, do you really want to be working with someone who's not a high net worth investor in these funds? I don't think it's worth the risk.
Jennifer Young: Yeah. Okay. Alright. So I think that wraps up everything that we were planning to discuss. I'm going to open it up for some questions. It looks like people were able to add in a lot of their questions. So we were just talking about regs. Is regs needed if money is moved to the US first in the form of an L L C with an E I N is my understanding It's not same
Kevin Kim: Analysis? Yeah, it's a different analysis. So if you've got a US L L C with its own e i n, that L L C is a US taxpayer, and so that's a US person. So remember people that an entity is considered a person. So the entity is a US taxpayer. If it has its own E I n, which also I'm wondering how it got the E I n, but if it got the E I n, then it's its own entity for tax purposes, not a discarded entity. So you're okay. You don't need Reg S in that context because the security being sold is happening here in the United States to a US L L C that has a US E I N, which will hopefully be paying taxes in the United States on that investment Right? Now, this is a very problematic issue though because this entity may have its own ECI problems. So that needs to be solved for, so the non-US investors should be consulting with a tax professional to make sure that it's aware of what its filing obligations will be if it happens to own A U S L L C with an actual tax ID number.
Jennifer Young: Can you generally But answer the question regs is not needed in that circumstance? That's a US investor for my purposes, Yeah. I think generally if there's an E I N attached to an entity, that entity is considered a US taxable entity, right? Correct. And it pays us taxes. Yeah. Correct. Okay. Next question. How are the exchange rates in Cayman and B V I? Since the US dollar was downgraded, I dunno if you know this off The top of head, we don't really deal with this. This is more for the administrators to deal with, but I don't believe that there's a problem with this because everything happens in dollars. So yeah. So when you have a feeder that's a Cayman or A B V I feeder, do we need to take into consideration the exchange rate or There probably is going to be an exchange rate because they're investing in home in US dollars.
Kevin Kim: If my family is coming into the Cayman feeder, they're investing from one into dollar into US fund, there probably is an exchange rate issue. But I mean, I don't think it's much of an issue really. I've yet to hear that exchange rates cause a massive for this, especially considering that we're spinning off nine 10% per annum, no withholding. I mean that kind of solves your problems right there.
Jennifer Young: Does the feeder docs usually require that the investment isn't made in US dollars or is there
Kevin Kim: Yeah, we put it in US dollars. We put everything in US dollars. We have an exchange rate disclosure, but that's really just a matter to address the issue that Julie's raised. Unlike there is a possibility that you may get less for your money, but that's just the reality of investing into a US program in US dollars.
Jennifer Young: The next one up. Does an investment taken as an unsecured corporate mezz debt work as in take advantage of the portfolio Interest? Yeah, so this is the question about debt
Kevin Kim: Instruments. So if you are offering under purely debt instruments, it will definitely work provided the debt instrument conforms with portfolio interest exemption. So I think I know who asked this question, and the only issue you run into is making sure that that doesn't affect your business negatively, but it can definitely work. I've done it many, many times. The only wrinkle that causes some problems for clients, that registered form component. So we just make sure that they're Okay
Jennifer Young: And the process for vetting non-US taxpayers. Do foreign investors need a US department certification? Homeland Security, treasury I R S or the like, I
Kevin Kim: Mean I don't necessarily know if those actually exist. So you can obtain one, but the law of those are falsified. So I don't necessarily love that. I tell clients the best way is to do your own homework. Don't let the investors say he's got the homework and you believe that. To me, it's kind of a flag. If anything, do your own homework. And the best practice there is if you have an AM M L K YC vendor for your lending business, that vendor will probably be able to help you on the security side. If you don't have one, go out there and find one. There's plenty of 'em out there. And your fund administrator should also be able to help you here. So do that. Do your homework, run your background checks or run the database searches and check the O effect database and all that stuff.
Jennifer Young: Do you see side letters with offshore LPs that could impact the leverage blocker structure? Oh,
Kevin Kim: Definitely. Yeah, definitely happens a lot. And that causes some issues because I kind of briefly talked on it. So one component that's kind of a newer development for these programs is that best practice is to get a transfer pricing, I guess opinion or memo on the interest rate being paid from the offshore feeder fund to the domestic blocker. Well, that transfer pricing memo, that whatever the number comes out at, right? Whatever the transfer pricing C P A tells you the number is, that's the interest rate you're being paid. And so if your site letter exceeds that, we might have a little bit of a problem. So we have to make sure we bless that. The CPAs bless it, we bless it. There's solutions. You have the equity component, and it may have a little bit of tax load on your side to deal with it, but it can be done.
Jennifer Young: So what's the potential workaround if they're asking for something that exceeds that ratio? Yeah, I
Kevin Kim: Mean if the note rate is top line, no matter what you do, it's a 10% for example, then you can't exceed that and you're trying to return at 11, you can use your equity component to spin off the extra 11. You can get a blessing from the CPA on one-off arrangement to exceed the interest rate payment on that particular account. There's discussions that you're going to have to have the CPA and the transfer pricing team to get clearance. This is not like you're selling watches in the United States, right? You're providing a service. Right. So it's a little bit different. Are
Jennifer Young: There low back considerations? Oh,
Kevin Kim: Thanks for the question, Vince. Flowback considerations, I mean, there's a lot of considerations that basically this goes sideways, what'll happen, but it's really hard to predict whether the tax laws are going to change. These are all kind of institutionalized tax regulations haven't been, they're not subject to, I guess cancellation or removal. And so that mitigates the risk of flowback. The one thing that I am nervous about and I've heard of happening is sponsors, they don't stick to the rules and they either violate p i e exempt the portfolio interest exemption, or all of a sudden they charge too much interest or something like that. And that can cause some problems. Or there's common control with the offshore feeder. Too much common control the trigger C F C requirements, so you got other violations that can trigger flow back on taxes, and that's more of an audit risk issue. I don't necessarily see a lot of it happening, but once again, most of these programs that we set up, they're also, they're working with a very, very well experienced C P A firm and fund administrator. So that really mitigates a lot of the risk. Would
Jennifer Young: Parta best practice for that be just to continually check or have your fund admin be checking for you quarterly or
Kevin Kim: Semi-Annually?
Jennifer Young: Yeah, I would make sure fund admin
Kevin Kim: Is checking things, monitoring things, making sure all the account is done correctly. And also the fund admin knows better most, and they're also going to be checking the client too. The client tries to deviate the fund admin will stop, raise the flag, escalate it to us and to CPAs and we'll have a discussion whether it's okay or not.
Jennifer Young: Good. Alright, a couple more questions. And Reg, as it was mentioned, the transaction has to be outside the us Many foreign investors have funds under their companies or personal names in US banks. There's also a possibility that the B B I Cayman fund also opens a US account under a foreign company in this case. Is there a problem for the transaction to occur in US dollars via US Bank
Kevin Kim: In those circumstances? Usually it's not an actual offshore investor. They don't qualify as a non-US person. They most often than not are a US person for tax purposes. But in that context, it will probably be okay because the transaction, the buyer is actually overseas and that's what Regas obsesses over. Is the buyer of the security in a foreign country and are they acquiring it? Is the offer being made into the foreign country? Is the sale happening in the foreign country or the remittance is happening on the US side? I don't think it's going to be as material, but that can cause a problem. If, for example, that person happens to be here in the United States,
Jennifer Young: I think ultimately likely the person that opens the bank or the company that opens the bank account, whether that person or that company is foreign.
Kevin Kim: What I have problems with is a lot of times is the offshore programs, these companies will set up a US bank, but the vesting will be different. So they'll have a subsidiary set up here, but they don't want to invest in a subsidiary, but they want to pay for that. They want to wire that subsidiary and, hold on, hold on, hold on. That's a big flag to me, right? The vesting has to match. That's a big money laundering problem.
Jennifer Young: What investment is worthwhile for investor to engage in master fee structure? Well, what dollar investment is worthwhile? So I think we're talking about, Yeah, I mean the client has to basically, basically million. Yeah,
Kevin Kim: This is Chris. I asked the question. I mean, Chris, you have to look at whether it's worth it for you. So the cost of my work, c p a work offer, council work,
Right? You have to weigh the cost and see if it makes sense for you. Most of the time, one five's probably not going to be enough. 10 is probably enough to start the conversation, but it's really dependent. So five might be worth it if it's going to be five now, five in the future, I don't know. But also the cost is what's material. We've done this for a lot of our clients now, and so we've gotten it down to a pretty strong science. It's not that bad, but it's definitely a legal bill, right? It's a pretty significant legal bill. So we have to talk about that.
Jennifer Young: And one more question. Have you been privy to an I R S action with a debt fund regarding a leverage blocker? We
Kevin Kim: Wouldn't be The ones that they call we're securities council, right? So most likely they're going to be calling the CPA firm or tax attorney. But when we do these structures, we're going through a CPA firm to get the blessing on the structure.
Jennifer Young: Alright, well we are at the top of the hour and we want to thank you guys for attending our webinar and I hope you found it helpful. We are here if you have any additional questions, you know where to find Kevin or myself and we hope that you have a great week and reach out with any questions. I hope everybody has a great Monday. Take care everyone.