BACKGROUND:
Alexanderthegreat #4170 is an international lawyer with 10+ years experience at top law firms. Following Dani’s AMA of 2 May 2022, where Dani expressed his vision to provide a more professional and legal set up to the WL project, I have prepared this brief memo to highlight some of the legal and tax points to consider in choosing to where, when and how to give WL the most efficient legal structure. I refer to Wonderland as WL and a potential merged Wonderland-Abracadabra as WL-ABRA.
I have tried to make the note as discoursive and ‘non-lawyery’ as possible but some basic knowledge of legal and tax concept is required (e.g. I am assuming the reader knows at least what is a capital gain).
I provide no personal opinion on what is best, I am just giving an unbiased professional view. Likewise, when I talk about tax havens in no way I mean to disrespect the governments of those countries or fellow frogs who hail from there: my focus is to set out the legal consequences of choosing one jurisdiction over another based on current laws and expected trends.
I hope you find this useful. Apologies for any spelling mistakes but I have tried to write this as soon as possible whilst managing normal work and life obligations.
TAKEAWAYS:
1.Given investors are from many different countries and legal jurisdictions, realistically there cannot be a one solution fits all but we can still aim for the most optimal solution for everyone. I am sharing my conclusions for US and European investors based on my professional expertise. It would be helpful if any investors with professional expertise from other areas of the world shared their input in this or in another document.
2.Dani is currently living in Dubai and during the AMA there was naturally a suggestion of exploring what a Dubai incorporation would look like. Put it bluntly, incorporating in the United Arab Emirates = taxation suicide for European and American investors. Even though the UAE corp. would not be subject to corporation tax, any gains made by individual investors would be taxed at higher and punitive rates in both the US and European countries (see the ‘Taxation’ section below).
3.The optimal solution would be to set up different corporations for each main areas of the world where investors reside. This is how large financial institutions operate. For example, at the beginning there could be a US corp. and an EU corp. (in Luxembourg or Ireland), with more added as needed depending on investors composition (e.g. a UK corp.). It would be useful to do an anonymous pool to better understand the current geographical location of investors.
4.The downside of this is that one would have to undertake several registrations and deal with several regulators. This is not a one lawyer job although an internal counsel can coordinate with external firms and manage costs. Expect at least 6-12 months per application. Also, each entity would need to have at least one representative who is fully registered as an investment advisor under the relevant laws of the country. This is something that needs to be considered when hiring and structuring.
5.From a practical investment perspective, the separate corps./funds can easily work in full coordination so that the economic power of the community as a whole would not be diminished. For example, say that there are two funds each of which holds 50% of the entire WL assets. The TM decides to make a $10m investment in XYZ asset. $5m will be invested from each corporate fund, thereby achieving the same economic result as if there was a single corporation.
6.Incorporation means that there will be a change in privacy for holders: everyone will need to be KYC-ed and their personal data shared with governments. The process would be similar to that required for registering with Coinbase to give you an example. This should not really matter because every investor, no matter where they are from, is legally obliged to disclose any gain made from WL or ABRA. However, I am aware that there may be investors who choose to adopt the strategy of total non-disclosure. These investors will be forced to disclose their identity or liquidate their investment.
7.In order to save time and costs, I would advise instructing lawyers only after a potential WL-ABRA merge has effectively taken place. This is because from an ethical and regulatory perspective it is extremely difficult, if not impossible, for a lawyer to act on two sides of a merger. In order to avoid doubling legal costs, it would be best to get lawyers onboard to set up the best legal structure after the two communities have already united their assets and are already operating as one.
8.The specific type of corporation and registration to choose for each fund will need to be considered once the community (WL or WL-ABRA) is ready to take that step. This is to avoid spending time and money in pursuing one form of incorporation only to be faced with new-crpyto specific legislation requiring a different type of registration. This will always be a risk but by being careful with timing and not jumping the gun it can be minimised as much as possible.
9.If we were to incorporate today, I would advise to follow the traditional VC / funds route of a limited partnership with investors acting as shareholders and the WL / WL-ABRA team acting a the managing general partner under a separately incorporated entity. This avoids being taxed twice (see ‘Taxation’ section below).
10.Becoming legally incorporated means that there should be internal process set up to fulfil all accounting, reporting and data privacy obligations of a corporate body.
11.Regarding the WL / WL-ABRA team, those who reside in the same jurisdiction of the funds can choose between becoming employees or contractors. Anyone else should work only as contractors to avoid needing to become tax registered in all of the jurisdictions where the workers reside, which would be highly inefficient.
TAXATION
The short read: investors are always subject to tax in their home jurisdiction even though they have investments in a foreign or no-tax country. At corporate level, there are common structures like limited partnership to avoid being taxed twice (at fund level and investor level) on the same gain. Incorporating in tax havens therefore does not bring any fiscal advantage but instead it attracts bad attention from regulators and tax authorities. In some jurisdictions having an investment in a tax haven means that the investor will be subject to a higher rate of tax. This is done to discourage movement of money to tax havens.
Finally, some countries, most notably the US, tax at a higher rate gains made from foreign funds when compared to gains made from American funds (even if the American funds invest in foreign assets). To give you a simple example: gains from a Dubai based WL fund would be considered to be ordinary income and therefore not subject to the long-term CGT exemption. Gains made from foreign investments made by a USA WL fund structured as a limited partnership would be taxed as CGT in the hands of US investors.
A bit of background and history
Although there each country has its own tax code, there are clear trends followed internationally, aided by the OECD as the catalyst for tax coordination (or harmonisation as tax authorities like to say).
A clear trend is a host of different legislation to discourage investments in tax havens (ie countries with no or minimal tax). The EU maintains a black-list of these countries. Although some countries, like UAE, have been recently removed from that list, domestically many European countries impose much higher rates of tax for investors who invest in a tax haven, irrespective of whether or not that tax haven is blacklisted by the EU.
Furthermore, at G7 level there is an ongoing discussion for a global minimum corporation tax rate. Therefore, countries who have come out of the naughty-list might get back into it in the near future. The clear trend internationally is to use laws and higher tax rates to prevent investments in tax haven jurisdictions. I do not expect this trend to change in the future.
So what’s the deal with tax havens?
It has always been the case in both the US and all EU countries (and the UK) that capital gains and income is taxed at home, even though the investment was in an asset located in a foreign jurisdiction with no taxation on capital gains.
So what’s the advantage of tax havens then? The main advantage is that tax havens have strict privacy laws jurisdictions preventing US and EU governments form finding out if any of their citizens held money there which they were not declaring at home. The tax game with tax havens, therefore, consists in either eventually going to live there or utilising complex legal structure to funnel the money back into the US and EU with a semblance of a clean / non-tax haven origin.
This was pretty easy to do until 10-15 years ago; then things changed pretty quickly. Today, many tax haven jurisdictions like the UAE are subject to compulsory disclosure of bank account holders and investors, therefore providing no advantage to foreign investors who do not actually live there. Jurisdictions who still refuse to share that information are an automatic red-flag for tax authorities who will assume that the investor had a tax evasion motive unless they can prove why they made their investment in that particular jurisdiction as opposed to another. Finally, in order to discourage investments in these kind of countries up-front, some jurisdictions have adopted a punitive rate of tax specifically for investments in countries with no or minimal tax.