Traditionally, families looking to transfer wealth down the generations in a tax efficient manner have used trust structures as they provide a well known flexible solution to separating legal and beneficial ownership. However, with trusts suffering an initial 20% IHT charge on assets settled over an individual’s nil-rate band of £325,000 and increasingly stringent reporting requirements, many families are seeking alternative solutions.
However, the challenge is to find a solution which minimises the overall IHT exposure whilst retaining benefits such as the control which a trust structure offers.
Family Investment Companies (FICs) are one such alternative, with FICs providing flexibility whilst allowing income to accumulate in the FIC at corporation tax rates which are lower than trust tax rates.
What is a Family Investment Company?
FICs are private companies, limited or unlimited (unlimited companies are not required to file accounts at Companies House), normally formed and controlled in the UK. Funds to form the FIC are usually provided by a senior family member, either by way of either an interest-free loan or by subscribing for preference shares which have no entitlement to income or capital above the initial subscription price.
The initial cash transfer is not regarded as a transfer of value for IHT purposes as there is no immediate diminution to the individual’s estate. The benefit therefore arises in fixing the value of the asset at the date of transfer for IHT purposes. Any subsequent transfer of loan balances/preference shares to the children or grandchildren, would be regarded as a Potentially Exempt Transfer (PET).
Other family members, children and grandchildren, will hold a separate class of share which benefit from most, if not all, of the income and capital appreciation rights.
What are the main benefits of a FIC?
- Unlike discretionary trusts a FIC can be established without an immediate tax charge.
- Dividends received by the FIC from most companies (and certainly the majority of UK corporations) are normally exempt from corporation tax.
- Interest received and non-exempt dividends would be subject to corporation tax at 19%.
- Capital gains will normally be subject to corporation tax of 19%, rather than the current main rate of 20% that would be payable by a trust.
- As with directors and shareholders of other family businesses it would be possible to pay a salary and benefits to those managing the company as well as pension contributions.
- As noted above, It is usual for the shareholders to have differing share classes, for example the founder(s) would hold shares with voting rights but without capital rights, whilst the children/grandchildren may hold differing share classes which only have an entitlement to income, allowing flexibility on the payment of dividends which may be voted independently on each class of share.
- There are significant anti-avoidance provisions which prevent a settlor accessing capital and income from a trust they have created. However, a FIC structure allows the founder to receive the repayment of their loan, income in the form of interest on the loan or dividends where they wish their shares to retain an entitlement to income.
What are the disadvantages?
- Transfer of assets such as property into the company may incur capital gains tax and stamp duty – only cash transfers are tax-exempt.
- Subject to the provisions of the trust deed, when new family members are born they can automatically form part of a class of beneficiaries. However, shares in a FIC would need to be issued or transferred to a new member, with the tax consequences relating to the allotment/transfer of shares being considered at that time.
- Regulations in this area are reviewed and changed frequently. The increased popularity of FICs has not gone undetected by HMRC. A regular review of the company structure is necessary to keep up to date with any legislative changes.
- It is worth noting that the FIC is unlikely to attract any inheritance tax reliefs due to its investment activities. The IHT planning is therefore in giving away capital appreciation but can go further where loans and preference shares are assigned.
FICs provide an attractive and reasonably flexible alternative to trusts for those who want to retain control over their assets, an important factor to consider in cases where beneficiaries may be younger.
FICs do not, however, offer the complete discretion that is afforded to discretionary trusts, nor do they keep the value of loans or shares out of any one person’s estate.
We have highlighted above some of the key areas to consider when choosing between a FIC and a family trust. Ultimately, though, it is important to consider all factors in deciding whether a FIC or trust is the most suitable option, including the family’s wealth, relationships, tax efficiency and long-term succession plans.
Should you have any questions as to how FICs may be used as part of your succession plans please contact either Simon Hopwood (firstname.lastname@example.org) or your usual point of contact at RG.