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IRS Drives Hedge Funds Out Of USVI

by Carla Johnson, Investors Offshore, London

31 January 2007

The IRS's clamp-down on abuse of US Virgin Islands tax incentive legislation has claimed some possibly unintended scalps as nearly half of the locally-registered hedge funds jump ship.

The USVI program, instituted in 1986 and extended in 2001, allows certain types of business with investment of at least US$100,000 and at least 10, mostly local employees, a 90% income tax deduction. 49 hedge funds took advantage of the program.

But in 2004, the IRS and Congress clamped down on abuse of the program by US citizens falsely claiming to be resident in the USVI in order to claim the tax break on income received from local businesses, or on income attributed to them because of their ownership of such companies. Under the new rules, incorporated in the American Jobs Creation Act of 2004 (AJCA) a person has to be resident for at least six months of the year in order to claim the tax break.

23 hedge funds have left the USVI since then, fearing an attack from the IRS, hedgie William Mosler told the International Herald Tribune. Said Mosler: "It's kind of like what happens to a community when a big company or an army base pulls out but on a smaller scale. Unfortunately, the fear is causing a case of running away from the police when you're not guilty."

Recently, Bloomberg reported that the US Virgin Islands is trying to encourage investment in high-tech companies after the Treasury extended the Islands' 90% tax break to businesses dealing in intellectual property in September.

The Treasury Department and IRS issued a comprehensive package of proposed and temporary regulations under the AJCA in April of 2005; final regulations were issued in September incorporating many of the comments received on the proposed and temporary regulations, including a number of revisions intended to better reflect the realities of life in the US possessions.

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