Family Investment Company

7 Apr 2021

cut out paper family in hands

A Family Investment Company (FIC) is a bespoke vehicle which can be used as an alternative to a family trust. It is a private company whose shareholders are family members. A FIC enables parents to retain control over assets whilst accumulating wealth in a tax efficient manner and facilitating future succession planning.

Structure

An example structure for a FIC could be as follows:

  • The parents provide funds to the FIC in the form of either interest-free loans or by subscribing for preference shares. This will not be regarded as a transfer of value for inheritance tax (IHT) purposes and these funds can be extracted from the company at a later date tax-free.
  • 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.
  • 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.

The company could be set up as a UK unlimited company rather than a UK limited company, in order to reduce the filing requirements. However, a ‘small’ limited company (turnover of less than £10.2 million and less than 51 employees, even if the balance sheet exceeds £5.1 million) will only need to file abridged accounts with no profit and loss account or directors’ report and there will be no audit requirement.

An unlimited company will not have the same protection from creditors as a limited company although, assuming that the only assets held by the company are, say, investments (and not property for example), it is unlikely that claims will be brought against the company.

It is generally advisable for families to appoint at least two directors to manage the FIC. This will ensure continuity of the company’s affairs in the event one director passes away or is incapacitated.

 

Rate of corporation tax

The company will pay corporation tax at the main rate of 19% (rate effective since 1 April 2017). 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’ at 19% will be introduced so that companies with annual profits below £50,000 will not be impacted by the change to the main rate. Where a company’s profits fall between the upper and lower limits, marginal relief provisions will apply to bridge the gap between the two rates.

However, the small profits rate will not apply to ‘close investment holding companies’ which by definition will include many family investment companies.

 

Capital gains

Capital gains realised by the company are chargeable to corporation tax at 19%). At present, this is lower than the current main rate of capital gains tax (CGT) of 20% that would be payable by an individual.

In addition, where assets were held prior to 1 January 2018, an indexation allowance will be available to reduce the gain chargeable to tax.

Where the asset 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.

Until 1 April 2023; proceeds from the sale of investments can therefore be reinvested in the company, having suffered less tax than would be the case for an individual reinvesting the proceeds of the sale of investments held in his own name. However, this will no longer be the case for the majority of FICs when the main rate of corporation tax increases from 19% to 25% from 1 April 2023.

 

Dividends

Most dividends received by a UK company (including foreign dividends) are exempt from corporation tax.

Distributions (ie dividends) received by a small company are exempt, provided:

  • The paying company is resident in a territory with which the UK has a double tax treaty with a non-discrimination provision;
  • The distribution is not interest treated as a distribution;
  • No tax deduction is given for the dividend outside the UK; and
  • The distribution is not made as part of a tax advantage scheme.

Interest may be treated as a distribution where it is paid in respect of non-commercial securities.

A small company, for these purposes, is a company with fewer than 50 employees and either a turnover or gross assets of not more than €10 million.

Distributions received by companies that are not small are exempt provided:

  • They are not interest treated as a distribution;
  • No tax deduction is given for them outside the UK; and
  • They fall into one or more of the exempt classes.

Most dividends will fall into one or more of the exempt classes. There are general and specific anti-avoidance measures, but in general, unless a distribution is paid as a contrived means of avoiding tax on what would otherwise be taxable income for the company, the anti-avoidance provisions should not be applicable.

 

Withholding tax on overseas dividends

Dividends and interest received from overseas may be subject to withholding tax. Rates of withholding tax may be reduced under the terms of the relevant double tax treaty and it is often easier for a company to obtain the benefit of the treaty rate of withholding tax than for an individual.

Withholding tax can be offset against the UK corporation tax on the corresponding income. It should be noted that if income is exempt from UK corporation tax, any withholding tax on that income will not be repaid by HM Revenue & Customs (HMRC) and so will be a tax cost.

Certain treaties will not allow a reduced rate of withholding tax to apply if the income is not subject to UK tax, but these are relatively few.

 

Tax relief on interest (eg to leverage a share portfolio)

The company will be able to claim a corporation tax deduction for interest on loans taken out against the value of its investments, where the loans are used for the purposes of the company’s business (eg acquiring new shares or generally managing its business). Loan interest deductions may be restricted where the total interest payable exceeds £2 million per annum (on a group basis).

By contrast, individuals are not eligible to claim tax relief on interest on loans to acquire a portfolio of shares.

 

Management expenses

Expenses incurred by the company in managing its investments and running its business will be eligible for corporation tax relief. This will include investment managers’ fees and remuneration paid to employees/directors. Certain items are not eligible for tax relief, such as entertaining.

By contrast, an individual investor cannot obtain tax relief on the expenses of managing his share portfolio.

 

Utilisation of tax relief on interest and management expenses

The company will be able to offset items against its taxable income – eg interest receivable and taxable dividends (ie dividends not exempt) – and capital gains.

Any excess amount can be carried forward and offset against the company’s future taxable profits from its investment business.

 

Accounting

Company accounts for nearly all FICs would need to be prepared in accordance with UK GAAP FRS102 (1A) standards and as a result, marked-to-market principles will apply on certain accounting items. This means that the company is taxed annually on the increase in value on a ‘fair value’ basis (rather than on disposal) on certain holdings. This can lead to the below issues:

  • Investments that are within the scope of the loan relationship rules for companies are subject to marked-to-market accounting. If the value of the investment increases, this can lead to ‘dry tax charges’ ie tax on unrealised gains. On the other hand, if the value of the investment falls then this can give rise to an allowable loss that can be offset against other income of the company. The investments that fall within these rules includes bonds, government gilts and other debt securities. Determining whether an investment falls within these rules is both a technical accounting and tax question that must be considered on a case by case basis.
  • It is also necessary for debtors and creditors balances to be accounted for on a marked-to-market basis. If debtors and creditors are denominated in a different currency to the accounting currency, where these balances are restated at the accounting year end at the prevailing foreign exchange rate, the subsequent foreign currency gain, if any, may be taxable. If a FIC is funded by way of a significant non-sterling shareholder loan, then the foreign currency movements could lead to volatile taxable profits despite no actual movements in the original currency.

 

Taxation at shareholder level

Shareholders will be subject to tax on profits extracted from the company:

  • Income tax on dividends – the highest rate is 38.1%. For lower rate taxpayers, eg children once aged 18, the amount in excess of the combined personal allowance and dividend allowance (£14,500 for 2020-21, and £14,570 for 2021-22) will be taxed at 7.5% at the basic rate and 32.5% at the higher rate.
  • Income tax on salaries (if the shareholder is also an employee) – up to 47% (including employee’s National Insurance contributions). Where the shareholder is resident in Scotland, the maximum rate will increase to 48% from 6 April 2018; or
  • CGT on capital distributions on the liquidation of the company – at 20%. Capital distributions on liquidation are, however, treated as income for tax purposes in certain circumstances (essentially where the recipient, or someone connected with them, carries on a similar business to that of the liquidated company in the two years following the distribution). In such cases the distribution will be subject to the relevant marginal rate of income tax (up to 38.1%).

There are potentially, therefore, two charges to tax on extraction of profits; one at company level and one at shareholder level, although this can potentially be managed depending on effective tax rates and the residence position of the recipients.

For families interested in setting up FICs, please note that in April 2019, HMRC set up a specialist unit to review the use of FICs as an inheritance tax planning vehicle. HMRC expressed at the time that the team’s work was of an exploratory nature and so whilst there have not been any significant changes to the taxation of FICs, it is possible that we may see new anti-avoidance rules created for FICs in the future. Therefore, it is strongly recommended that formal tax advice is sought prior to setting up a FIC.

This factsheet is based on law and HMRC practice at 1 April 2021.

DOWNLOAD PDF

Loading