We have been advocating the use of family investment companies (FICs) for the past two decades, in particular on our bi-annual tax conferences to property investors. HMRC recognised that family investment companies (‘FICs’) had become an increasingly popular tool for estate and inheritance tax (IHT) planning. In 2019 HMRC established a specialist unit to examine the tax avoidance risks associated with FICs. Recently, HMRC disbanded that unit after no evidence was found between the use of FICs and non-compliance with tax. This is good but not unsurprising news!
Having advised on various FICs and hybrid structures involving onshore and offshore trusts, foundations, and limited liability partnerships I have not experienced noncompliance. Admittedly some families like to be ‘assertive’ with their planning and structuring but when it comes to the passing of family wealth, most prudent families plan early and alleviate the need for aggressive structuring.
In the past decade or so, certain structures such as ‘Asset Trusts’ have been promoted although infrequently do the clients understand what they have placed assets in. The asset trust I refer to is also commonly referred to as a remuneration trust although structured to facilitate holding of assets for a surviving spouse and descendants. The trust during the lifetime of the principal is not actually for their or his family’s benefit although benefit is structured through a supplier relationship. It sounds a little strange and it often amazes me a wealthy person uses them to facilitate estate planning when other options such as the FIC have simply been overlooked. I would at least expect a wealthy person or entrepreneur to want to understand what they are doing.
An FIC is an alternative to a family trust. It is a private company. The shareholders are family members. The Articles and provisions of a FIC can be structured for the specific needs of a family. This permits control over aspects such as distribution of profits, the return of capital, transfer of shares and the appointment of directors. A FIC enables parents to retain control over assets, accumulate wealth in a relatively tax efficient manner and facilitate succession planning.
Parents retain control by subscribing for shares with voting rights. The children could be given or could subscribe for shares without voting rights or with limited voting rights. There is also a potential to give shares with differing capital interest for example, capital growth shares. Shares could be subject to pre-emption rights on specific terms, enabling shares to be acquired back from children if appropriate at some future point.
The parents also subscribe for voting shares in the FIC, which give control of the company at shareholder and board level.
The parents could also subscribe for a class (or classes) of non-voting shares. The parents can then choose to give non-voting shares to their children (preferably before significant value accrues to those shares). The gift will not be subject to IHT, provided the parents survive for seven years from the date of the gift. The non-voting shares may pay dividends in future.
When a parent makes a gift to their children, it is both a disposal for capital gains tax purposes at market value as well as a potentially exempt transfer for IHT purposes. From a CGT perspective, the aim is not to create a gain subject to CGT. Gifts of shares with value could be made regularly to utilise the available annual exemptions.
Alternatively, parents could make an interest free loan or subscribe for preference shares to provide the FIC with capital with which to invest. This should not be a transfer of value for IHT purposes and would not give rise to a CGT. The funds can be extracted from the company at a later date tax-free. Evidently, this would not reduce the estate for IHT purposes and further planning may be required over time.
A similar option could be for the parents to capitalise the FIC and the children to subscribe for capital growth shares.
Interaction with trusts
The parents could also put funds into a discretionary trust for the benefit of their minor children without triggering an IHT charge, to the extent that their IHT nil rate bands and annual exemptions are available (maximum £662,000). The parents should be irrevocably excluded from benefiting from this trust. The trustees then subscribe for a class of non-voting shares in the FIC at market value, ie at nominal value if the company is being newly created.
Grandparents could also put funds into a discretionary trust for the benefit of grandchildren. A grandchildren’s trust has the particular advantage that income distributed is treated as the grandchildren’s income thereby allowing them to utilise personal allowances and lower income tax rates. Grandchildren’s trust are normally a great way of facilitating the payment of education fees and other maintenance costs.
There are a number of other benefits of using trust, for example establishing a protective trust so family assets are afforded some protection in the event of divorce, creditor claims or bankruptcy of a potential beneficiary.
The small profits rate will not apply to close investment holding companies. Most FICs will be a close investment holding company and therefore the main rate is likely to apply. However, it is still lower than the higher rate of income and may therefore be beneficial if the desire is to accumulate wealth.
Corporation tax is to increase from 19% (since 1 April 2017) to 25% from 1 April 2023. The rate will apply to companies with annual profits exceeding £250,000. A ‘small profits rate’ at 19% will apply to companies with annual profits below £50,000. Where profits fall between the upper and lower limits, marginal relief provisions will apply between the two rates.
Capital gains realised by the company are chargeable to corporation tax. At present, the rate of corporation tax is lower than the rate of CGT payable by an individual. Proceeds from the sale of investments can currently be reinvested having suffered less tax than would be the case for an individual reinvesting the proceeds. The rate of corporation tax from 1 April 2023 will however be higher unless CGT rates are also increased.
If the asset being disposed of is shares in a subsidiary company, Substantial Shareholdings Exemption may be available to exempt the gain. Detailed conditions apply, but broadly the FIC would need to hold at least 10% of the company being disposed of, which would itself need to be a trading company.
Most dividends received by a UK company (including foreign dividends) are exempt from corporation tax.
Dividends and interest received from overseas may be subject to withholding tax. The UK has a considerable network of double tax treaties which may be reduce the rate of withholding tax. Withholding tax can be offset against the UK corporation tax on the corresponding income that is subject to corporation tax.
Dividends declared are taxable on the recipient according to their tax status and other income.