At its simplest, a Family Investment Company (FIC) is a structure that can be used to transfer value to the younger generation while allowing the older generation to maintain control over the assets and without creating an immediate inheritance tax (IHT) charge. The use of a FIC is increasingly seen as a popular alternative to a family trust.
HM Revenue & Customs’ view
In April 2019, HM Revenue & Customs (HMRC) set up a team to review the use of FICs. At the time, it was stated that the team’s work was of an exploratory nature.
HMRC has recently published its findings, concluding that it now has a better understanding of the characteristics of FICs and the use of these structures does not suggest those taxpayers that use 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, we may see new anti-avoidance rules in the future.
FICs are now being brought into ‘business as usual’ within HMRC. Such entities will not require to be dealt with by a dedicated team at HMRC.
Establishing a FIC
A FIC is a private company that is controlled and run by its directors, with family members, possibly including family trusts, owning the shares.
The FIC’s Articles of Association can be tailored to the specific needs of the family to create a bespoke vehicle that meets their particular needs, often as an alternative to a family trust. The articles can be used to determine matters such as the appointment of directors, distribution of profits, the return of capital and the transfer of shares. This enables parents to retain control over assets whilst accumulating wealth in a tax efficient manner and facilitating succession planning.
The parents can retain control by subscribing for shares with voting rights, which give control of the company at shareholder and board level.
The parents can then choose to gift non-voting shares to their children or make cash gifts to allow them to subscribe for non-voting shares. Alternatively, the parents could settle shares or cash for subscription of shares onto a trust for the benefit of their children.
Although particular care is needed in their structuring, FICs are typically funded primarily by way of shareholder loans from the parents, with only a small amount of share capital. The repayment of these loans using cash generated by investments held by the company is tax-neutral. Only when their initial loans have been fully repaid will further extractions from the FIC trigger tax charges in the hands of the parent shareholders.
FICs can also be tax efficient vehicles by bringing income within the corporation tax regime instead of the charge to personal taxes.
A company will pay corporation tax at, currently, 19% which is generally lower than personal income tax rates (the top rate being 45%/46%). In addition, no corporation tax will be payable on the majority of dividends received by a company and management and business expenses will often be deductible for corporation tax purposes when they would not be for individuals.
FICs are particularly efficient if profits are retained in the structure for reinvestment. There will be additional tax at shareholder if profits are extracted from the company, for example by dividends.
Based on the current UK corporation tax rate of 19% and dividend rate for individuals of 38.1%, the effective rate of tax on generated by a FIC which are extracted for personal use is 49.5%.
From 1 April 2023, the rate of corporation tax for FICs will be increasing to 25%. Subsequent to this change, using current income tax rates, the effective rate of tax when extracting profits as a dividend for personal use will increase to 53.6%. The effective tax rate of 53.6% exceeds the current highest level of income tax in England and Wales of 45% and 46% for Scottish taxpayers.
The conclusion of HMRC’s review implies that it does not view the use of FICs at the most aggressive end of tax planning, although we must wait and see whether we get future changes to the taxation of FICs, especially where they are used to roll up profits at lower corporate tax rates. For the time being, and even when corporation tax rates increase in 2023, their use can still be an attractive option for parents or grandparents who wish to pass on wealth to the next generation whilst still retaining control over the assets.
If you would like to discuss FICs and how they could be used for your family, please speak to your usual Saffery Champness partner, or contact Hilary Clelland.