Family Investment Companies and Estate Planning
Family Investment Companies (FICs) and Personal Investment Companies (PICs) are an increasingly familiar feature of the tax-planning landscape.
FICs provide a flexible vehicle for the holding of investments and permit the tax-efficient accumulation and distribution of profits to family shareholders. Individuals establishing personal investment companies, where they are the sole shareholders, can also benefit from many of their features.
There are a number of reasons for the growth in popularity of FICs:
- Changes introduced in Finance Act 2006 made trusts less attractive as vehicles for holding family wealth. Consequently, advisers have sought to develop other structures that provide similar benefits but without the restrictions applying to trusts, in particular, inheritance tax charges of 20% on contributions in excess of the trust settlor’s available nil rate band.
- The divergence between the rates of tax applying to individuals and trustees (up to 45%) and companies (currently 19%) has provided a further spur toward incorporation and holding family wealth within a company.
How does a family investment company work?
Family investment companies are bespoke structures. However, a typical situation is as follows.
Having exited a successful business, an individual decides that he wishes to tax-efficiently share his good fortune with the wider family. Rather than contribute those funds to a trust, which could result in immediate charges to inheritance tax, he incorporates a new company, with different classes of share to be held by various members of the family. He funds the company by way of an interest-free loan and the company, in turn, invests those funds in a portfolio of shares and securities.
The founder is able to access funds from the company by way of repayment of his loan while family members can be remunerated by dividend payments.
Ongoing Taxation of Family Investment Companies
The key advantages of a family investment company include:
- Dividend income is generally exempt from corporation tax in the hands of the company.
- Other income and gains realised by the company are subject to corporation tax (currently 19%, scheduled to reduce to 17% by 2020).
- No inheritance tax on the establishment of the company or the subsequent gift of shares to family members. Unlike a trust, a FIC is not subject to inheritance tax charges on each ten year anniversary.
- Relief is available to the company for interest on any loans it takes out against the value of its investments whereas, in contrast, individuals and trustees are not eligible for tax relief in respect of interest on loans to acquire investments. The mortgage interest relief restriction applying to individuals and trustees also does not apply to companies and therefore a family investment company investing in residential property, and using loans to acquire those properties, would be able to get full relief for the interest costs.
- Relief is available for expenses incurred in managing the company’s investments and running its business. This includes investment manager’s fees. In contrast, individuals are not eligible to claim tax relief on the expenses of managing an investment portfolio. The company may also be able to claim a deduction for salaries and pension contributions paid to or on behalf of the employees or directors of the company.
The result is that the FIC will have more post-tax income available to reinvest and generate further income and capital growth than if investments had been held by individuals or trustees.
Family Investment Companies & Shareholder Taxation
Shareholders will be subject to tax on profits extracted from the FIC.
Dividends will be subject to tax at the appropriate marginal rate (7.5% for basic rate, 32.5% for higher rate and 38.1% for additional rate taxpayers). For taxpayers with no other sources of income, up to £13,850 of dividends can be paid in the 2018/19 tax paid in the 2018/19 tax year without incurring any further taxation (i.e. using their personal allowance of £11,850 and dividend allowance of £2,000).
If the original shareholder funded the company by way of loan, repayments of that loan can be made without incurring any additional tax liabilities.
Ultimately the company might be liquidated in which case distributions to shareholders should be treated as capital distributions and subject to capital gains tax at 10% or 20% to the extent that they are basic or higher rate taxpayers.
Inheritance tax and Estate Planning
- When the company is incorporated, shares can be gifted to family members without incurring any immediate tax charges on the basis that they have little or no value at the date of incorporation and therefore there are no concerns with capital gains tax. The gift of the shares will be treated as a potentially exempt transfers for inheritance tax and therefore all outside the estate of the donor provided they survive at least seven years. If the donor dies within seven years, it will be the value of the shares at the date of the gift, rather than at the date of death, that is brought into their estate and subject to inheritance tax.
- Should the donor continue to hold shares in the FIC at the date of death, the value of those shares will be discounted to reflect the size of the shareholding and restrictions imposed in the articles and any shareholder agreement on the sale of those shares. The discount might be substantial meaning that the value remaining in their estate is significantly less than the percentage shareholding.
- If the FIC was funded by way of loan, that loan will remain within the founding shareholder’s estate for inheritance tax purposes. However, they could consider gifting that loan to other family members allowing them to receive tax-free repayments of the loan. The value of the loan would fall outside of the founder’s estate after seven years.
Non-tax considerations of a Family Investment Company
The potential benefits of FICs extend beyond taxation.
As a tax-wrapper, a FIC is not subject to Financial Conduct Authority regulations and can invest in a wide range of products.
The directors control the FIC, including its investment decisions and when and to whom distributions of profits are made. It is not necessary for parents, for example, to retain a majority shareholding to continue to exercise control. The articles can prevent a transfer of shares other than to certain family members or family trusts and the value of the shares will further be reduced by the restrictions in articles and shareholder agreement.
Further protection against the transfer of the shares outside the immediate family such as the requirement for shareholders to enter into pre-nuptial agreements could be included in a shareholder agreement.
Family Investment Companies vs Trusts
Changes in the taxation of trusts in 2006 have been a key driver of the growing popularity of family investment companies.
Nevertheless, trusts remain useful in the right circumstances and for many families they remain the most flexible and appropriate tax-planning vehicles. For example, while the transfer of cash in excess of the nil rate band into a trust will give rise to an immediate charge to inheritance tax, shares or other assets benefiting from reliefs such as business property relief can be transferred into trust without giving rise to any liabilities. Shares in a family company might therefore be transferred into trust prior to the sale of the business to a third party – but before there is any binding contract for sale – and the value passed into trust without any immediate charges to inheritance tax.
The trustees would then receive a share of the proceeds of sale of the business and are free to reinvest those proceeds on behalf of the beneficiaries of the trust.
It might also be appropriate that a trust is used to hold shares in a family investment company. This can be especially attractive for creating a pot of income that might be used to provide distributions to family members who are not named shareholders in the FIC.
Should I Set Up a Family Investment Company?
FICs attempt to mirror some of the advantages of discretionary trusts and provide a means of transferring value to other family members while still permitting the retention of control. For many families, trusts will remain the most flexible wealth planning vehicles; however, FICs come into their own where the value of the assets to be transferred are such that they would be subject to an immediate 20% lifetime inheritance tax charge.
Enterprise Tax Consultants can advise on all aspects of Personal Tax Planning.
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