An offshore fund is a fund which is based in an offshore financial center. Offshore financial centers are nations which provide incentives for international companies to settle within their borders for the purpose of doing business. At an offshore fund, the fund is based in one country, and the clients are based in another. Some people use the term “offshore fund” in general to describe any type of international investment, whether or not the fund is located in an offshore financial center.
The key feature of an offshore financial center is a low tax rate, which is usually paired with light regulation. Such nations use low tax rates to attract financial companies under the argument that the sheer volume of business makes up for the reduction in tax revenue. Minimal regulation from the government also makes such sites appealing for funds and investment companies.
From the point of view of an investor, working with an offshore fund increases returns because of the reduction in taxes paid, and because light regulation can sometimes allow funds to undertake riskier, but potentially more profitable, investments. The downside to this, however, is that some offshore funds are actually better characterized as scams, and people must be careful about how and where they invest. It is better to work with a reputable financial company which has an offshore branch than to invest with a total unknown.
Another problem with an offshore fund is that when funds are repatriated, people must pay taxes. For example, a French citizen investing in a fund based in Bahrain might pay minimal taxes in Bahrain, but as soon as the funds were transferred to France, heavy taxes would kick in. Many governments with high tax rates have gotten more aggressive about pursuing tax shelters, and do not take kindly to attempts by investors to hide profits from offshore funds.
Many offshore funds are based in the Caribbean, where numerous nations have lax financial laws. Some parts of the Middle East are also appealing for the financial sector, along with Luxembourg, Jersey, and the Channel Islands. These funds work just like domestic funds, with funds from numerous investors being pooled to invest in large-scale schemes. A single investor acting alone does not have very much investment power, but when her or his funds are lumped with those of numerous other investors, it can generate a block of money which can be used for more clout.