Bahamas SMART Funds for High Net Worth Brazilian Residents

The advent of globalization and the increased economic growth of emerging markets have given birth, especially in Brazil, to a new type of family (the so-called “multi-jurisdictional family”). This family type has an entirely new way to establish its relationships, and its members are searching for new opportunities to expand their network of ownership and relationship overseas. For these recent born families, it is common to have members residing abroad and assets allocated in different jurisdictions, which demands new wealth planning solutions.

These changes in the pattern of the standard family unit have forced professionals who work with its members to search for global wealth solutions that can bring answers for their needs. In this scenario, the offshore investment funds represent an interesting response in terms of governance and investment decision.

Recent research shows that Brazil is the home country of a large number of these families. It is estimated that the Brazilian market will generate 500,000 new millionaires by 2016, which certainly shows the relevance of Brazil in the global offshore funds market.[1]

Taking the above described context into consideration, this article will explore the benefits of a Specific Mandate Alternative Regulatory Test Fund (“SMART fund”), as a sophisticated, cost attractive and flexible wealth planning tool for high net-worth Brazilian residents.

Why should a high net-worth Brazilian resident choose a SMART fund as his/her vehicle for offshore investment?

A Bahamas based investment fund may be structured as a Unit Trust, a Company or a Partnership[2], nevertheless in order to be treated as a SMART Fund, the structure must be incorporated in respect to one of the SMART Fund Models, in accordance with The investment Funds (SMART Fund) Rules, 2003, 2005 or 2009.

According to the Guide to the Bahamas SMART Fund published by Bahamas Financial Services Board “The SMART Fund programme was designed to provide industry with a new Private Wealth Management tool with the flexibility to find application within areas not traditionally associated with investment fund administration. The primary facility offered by the SMART Fund concept is an open architecture which allows practitioners to design innovative structures, akin at times to special purpose vehicles, without reference to inflexible regulatory criteria predefined in legislation.”[3]. The SMART Fund program aims at improving Bahamas regulatory and business environment and was designed to easily match a wide range of possibilities in the Wealth Management industry. The referred flexibility makes the fund a highly customizable vehicle, which can meet the needs of different types of investors. As an immediate consequence, it becomes an important tool in an offshore wealth planning structure.

In this sense, the SMART fund framework presents some important aspects to be considered by Brazilian residents when deciding for their wealth management. First, it allows for investment in a broad range of asset types, including, but not limited to, private equity, collectable furniture, collectable art and financial assets. Once incorporated as a Segregated Account Company (“SAC”), under the Segregated Accounts Companies Act, 2004, the fund may create separate accounts with assets and liabilities which are segregated from the assets and liabilities attributable to the other accounts.

This enables the SMART Fund to issue different classes of shares with separate portfolios. Each class may invest in a specific type of asset, allowing for segregated funds, as well as different Net Asset Valuation (“NAV”) according to the nature of the assets individually considered, as well as segregation of liabilities between the different portfolios.

Second, the fund segregation also allows the investor to have different portfolios managed by different managers, which is a critical point for a financial advisor image risk. In case the fund was not incorporated as a SAC, the portfolio managed by each of the portfolio managers would be held liable for the other portfolios liabilities. And at the end this segregation also works for the benefit of the investor, once the different NAV calculation enables a better portfolio performance evaluation.

Third, in terms of Brazilian wealth planning strategy, the SMART fund may also be viewed as a tax efficient vehicle. Brazilian residents are taxed in a worldwide basis and the majority of their offshore financial income is subject to capital gain at 15 per cent tax rate, exception made for dividends, taxed at gradual rates of up to 27.5 per cent. In case the portfolio is highly concentrated in assets that distribute profits frequently, the management costs of such portfolio would be high, considering that for every time profits are distributed, there would be tax consequences in Brazil. In light of the above, the allocation of assets in vehicles that do not distribute profits on a regular basis is an usual tax planning method for Brazilian residents holding offshore assets. Generally there are two structures that would meet this goal: offshore funds and offshore companies. Comparing both these structures, the SMART Fund would represent all the benefits described previously as well as lower income tax rates. The income received from redemption funds’ shares is subject to 15 per cent rate income tax. While the dividends distributed by offshore companies are taxed at gradual rates up to 27.5 per cent.

For those investors who have already incorporated an offshore company as an investment vehicle, the SMART Fund regulation allows for its conversion into a SMART Fund. It is possible for the investors to switch from one structure to another efficiently and with low cost, as it would not involve necessarily the liquidation of the offshore company prior to its conversion into a SMART Fund.

Finally, compared to other jurisdictions’ funds legislation, SMART Fund Act provides a simple and friendly framework. There is no legal requirement for Offering Memorandums, which are usually lengthy and time-consuming documents. It is only mandatory to have a simple Term Sheet (Term Sheet mandatory information differ according to the SMART Fund Model). Most importantly, it is mandatory that every SMART Fund be licensed by the Securities Commission of the Bahamas or by an Unrestricted Fund Administrator according to each of the SMART Funds Models.

In the interface between a SMART Fund and Brazilian jurisdictional issues, what are the main points a Wealth Planner should consider?

The main obstacle in the analysis of an offshore fund through the light of the Brazilian legislation is the inevitable analogy with onshore funds. Despite the similarities, these vehicles have different natures. Brazilian Investment funds are incorporated as an association of investors (a condominium), and are not regarded as a separate legal entities. For legal purposes, it is the administrator who represents the fund in every act undertaking. Offshore funds, on the other hand, are mainly incorporated as companies raising some differences in the role of the players of such funds (i.e. fund manager, administrator, director).

Furthermore, every individual or entity that acts as fund manager of Brazilian investment funds must be authorized to operate by the Brazilian Securities Commission (Comissão de Valores Mobiliários or “CVM”), in accordance with CVM Normative 300 of May 5^th, 1999. The referred rule does not make any reference to Brazilian individuals or entities acting as offshore fund managers. Despite of not representing a current risk, over time this may possibly change in case CVM decides to review its position or to enact new rules affecting offshore funds. This should certainly be a point of attention for Brazilian wealth planners.

In addition, it is important to properly report to Brazilian authorities the investment made through the SMART fund. Generally, Brazilian residents are required to file two reports during the calendar year: a tax return with the Brazilian Revenue Services (Receita Federal do Brasil, or “RFB”) by April 30^th; where they must list all of their assets as well as the income received during the year; and the Brazilian Offshore Capital Declaration (“DCBE”) with Brazilian Central Bank, required to be filed annually for individuals or entities holding assets abroad in the total amount of US$100,000 or more, and quarterly for individuals or entities holding US$100,000,000 or more in assets abroad. Once a Brazilian resident invests in a SMART Fund, it is essential that shares ownership is informed both to the RFB and to the Brazilian Central Bank in an accurate manner.

Another point of attention when dealing with offshore funds refers to the foreign exchange register. Brazilian exchange market is controlled by Brazilian Central Bank and it is ruled by the International Capital and Foreign Exchange Market Regulation (Regulamento do Mercado de Câmbio e Capitais Internacionais or “RMCCI”). Every time a Brazilian resident invests money abroad, the foreign exchange transaction must be registered with the Brazilian Central Bank with a specific nature (code) chosen from a list available on RMCCI. Thus, when investing in offshore funds, the financial professionals assisting the investor must take this aspect into consideration and check if the investor foreign exchange nature will be kept the same or if that must be changed. This is particularly important when converting a company into a fund.

In conclusion, the SMART Fund legislation provides an innovative and efficient tool that should be considered as an interesting and cost attractive effective alternative by Brazilian Wealth Planning practitioners. It enables a great level of governance and the possibility of having an umbrella vehicle holding most of investor’s assets abroad, still respecting the unique nature of each kind of asset, as well as being a tax efficient structure.However, the structure must be used with caution. The particular situation of each investor always presents details that could severely interfere on the correct planning. There is no standard rule in this context. The funds interface with Brazilian jurisdiction must always be evaluated by highly qualified professionals capable of presenting a global vision over the structure impacts.

The world is always changing, life is dynamic, and so are the people’s needs. As the requirement for overseas relations grows, the professionals must also develop their skills in connecting different jurisdictions rules and combining the scenarios that best fits their clients’ interest. On this search for this economic and law optimal point, initiatives such as that of the Commonwealth of The Bahamas and its SMART Fund are always welcome!

Disclaimer

The opinions expressed in this article are those of the individual author and may not reflect the opinions of Itau Private Bank.

[1] MERRIL LYNCH e CAPGEMINI, World Wealth Report 2011,at: http://www.capgemini.com/insights-and-resources/by-publication/world-wealth-report 2011/?d=BCD137B0-8001-3261-87C2-98873EFF1DF0.

CREDIT SUISSE, Global Wealth Report 2011, at:

https://infocus.creditsuisse.com/data/_product_documents/_shop/323525/2011_global_wealth_report.pdf

^[2] In accordance with The Investment Funds Act, 2003.

[3] Available at: http://www.bfsb-bahamas.com/guides/pdf/082736400.pdf