Answers to Questions and Problems

5.12
Partnership accounting and tax reporting are significantly more com-
plicated than accounting and tax reporting for a corporation. A part-
nership must maintain the cost basis of each investor in each asset.
Usually, a partner will have many different costs for each asset. Be-
cause a corporation is taxed as an entity, it is not necessary to preserve
details for individual investors.
5.13
With a master-feeder structure, it is possible to maintain one portfolio
and accept investment from both U.S. and offshore investors. Only
one track record is created and there is no possibility for the two
groups of investors to receive significantly different returns.
5.14
Many mirrored funds were created before the master-feeder structure
was created. Also, it is much easier to create a second, mirrored fund
if the first fund is already operating and has a number of assets with
costs already established. Finally, the cost of setting up the master-
feeder structure is higher than setting up either a U.S. or an offshore
fund (although probably cheaper than setting up both a domestic and
an offshore fund).
5.15
Lawyers and accountants have favored Delaware. Most states have
responded by making their states very competitive as business domi-
ciles. For many kinds of businesses, the state the business is located in
would serve as a good domicile. It is important to discuss the location
question with your lawyer.
5.16
It is important to locate the fund in a domicile with low or no taxes,
so that investors can avoid unnecessary double taxation. Beyond that,
some countries have greater protection of privacy, a stronger legal tra-
dition, conveniences in terms of travel time to the domicile, and time
zones that are more convenient to the manager and investors. In addi-
tion, it may be important to pick a domicile that has language skills
matching the language of the fund's investors. Finally, some domiciles
are more prepared to deal with special requirements, such as religious
or cultural rules.
5.17
In order for offshore investors to avoid backup withholding, the U.S.
Internal Revenue Service must deem the hedge fund to be a non-U.S.
business. If the fund is administered in the United States, the IRS will
probably assert that the business is a U.S. entity and require the fund
to withhold taxes for the offshore investors.
CHAPTER 6
Hedge Fund Leverage
6.1
The stock loan agreements that show up as liabilities include the
money borrowed to finance the long stock positions. Traders think of
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