We are seeing increasing levels of enquiries from our land-based clients curious to find out more about Family Investment Companies and their possible use as an alternative to the more traditional trust structure.
What is a Family Investment Company?
A Family Investment Company (FIC) is a private limited company whose shareholders are family members. The company is usually set up by parents or grandparents, often with multiple classes of shares, each with differing rights.
A FIC can be used to transfer value down the generations in a tax efficient manner, whilst still allowing parents to retain control over assets.
The rationale is that the assets, usually cash, can be invested by the FIC, allowing future value to accrue in the company shares that are held by the younger generation. The cash injected into the FIC is usually invested into either a stocks and shares investment portfolio, or land and property.
Tax benefits of a FIC
A key benefit of a FIC is that inheritance tax (IHT) is not generally incurred on the initial setup of the company in the same way it can be with settlement into a trust. Settling assets into trust is a chargeable lifetime transfer (CLT), subject to IHT, although reliefs can be available.
The initial cash injection into the company can be treated as a loan and repaid, tax-free, at a later date.
A further benefit is that, in most instances, dividends from investments held within a FIC are exempt from corporation tax.
Investment management fees are also currently allowed as a deduction against corporation tax in a FIC, whereas in a trust they are not a tax-deductible cost.
FICs benefit from the lower rate of corporation tax on any non-exempt income, currently 19%.
However, the main rate of corporation tax will increase from 19% to 25% from 1 April 2023. This rate will apply to companies with annual profits exceeding £250,000. A ‘small profits rate’ of 19% will apply to companies with annual profits below £50,000, which will therefore not be impacted by the change to the main rate (there will be marginal relief between these two thresholds).
However, the small profits rate will not apply to ‘close investment holding companies’ which will, by definition, include many FICs.
FIC profits extracted as a dividend will be subject to income tax in the hands of the recipient shareholder, in addition to any corporation tax already suffered on those profits by the FIC.
Discretionary trusts are often used to provide flexibility as to who will receive any income, but these are charged to tax at the highest income tax rates.
Typical structure of a FIC
The older generation will generally establish the FIC through making a cash loan and subscribing to the initial share capital in the company. Preference shares can also be used. The cash would be used for the initial investment by the company.
The shares held by the older generation could be ordinary shares with voting rights, rights to capital and rights to dividends as voted by the directors – essentially standard ordinary shares.
Shares without voting rights, but with a right to dividends, could be issued for the benefit of the children. A third class of share, C shares, could then also be issued. These could be growth shares, with no voting or dividend rights, but with an entitlement to future capital growth.
A gift of shares to children would be a potentially exempt transfer for IHT, and the value of the gift would fall out of the donor’s estate for IHT purposes, provided they survived the gift by at least seven years. Any shares in the FIC would be of a negligible value initially as the company would have only the cash from the loan to the company, and the corresponding liability.
Because of the negligible value, there should be no, or minimal capital gains tax (CGT), on any gift of shares, provided they were gifted soon after set-up of the FIC and before any significant increase in value of any investment.
When investing in property, care must be taken to ensure that the FIC does not fall foul of the Annual Tax on Enveloped Dwellings (ATED) regime. This tax applies to residential properties worth over £500,000 held by a corporate entity, where an annual tax charge is levied based on the value of the property, although reliefs are available against this tax.
Why not a trust?
FICs have been badged as an alternative to trusts, with the key benefits outlined above in relation to IHT and taxation of income. However, FICs do also have the burden of the compliance regime for limited companies (not that trusts don’t have compliance requirements of their own). The winding-up of a corporate entity can also be complicated.
In practice, FICs are often used in conjunction with trusts, with shares for younger generations being placed into trust, giving trustees even more flexibility over how and when shares, and the income arising thereon, are applied for the benefit of the beneficiaries.
What is HMRC’s stance?
Whilst some of the benefits, such as the lower rates of tax on income, will soon be further eroded, the clear potential IHT benefit remains. FICs are therefore an efficient tax planning tool to be considered as part of general succession planning.
Whilst such a benefit exists, there is always the concern that new legislation could be introduced to negate the use of FICs in any tax planning, resulting in a corporate entity which could be costly to maintain or wind up, and which has limited tax advantages.
HMRC established a specialist FIC team in 2019 to undertake a review of FICs and the associated tax implications, with a focus on IHT.
The findings of that review were published in 2021, concluding that HMRC had a better understanding of the characteristics of FICs and that there is no suggestion that those taxpayers using them are non-compliant when it comes to their tax affairs.
Whilst so far there have not been any significant changes to the taxation of FICs specifically, nor any suggestion of such, there is always the possibility of new anti-avoidance rules in the future.
To find out more about Family Investment Companies, speak to your usual Saffery Champness contact or get in touch with Erica White, E: [email protected].