Sam Inkersole explores the pros and cons of using a family investment company.
There has been an increase in interest in family investment companies (FICs), and a recent comment from the Chartered Institute of Taxation (CIOT) suggesting that FICs have now been given HMRC’s ‘blessing’.
Prior to the latest Budget on 3 March 2021, rumours were circulating that there would be increases in the rates of capital gains tax (CGT) and changes to the inheritance tax (IHT) regime. Ultimately, these changes did not happen, but this has not stopped individuals from exploring whether an FIC would be beneficial to them and their families, as a way of reducing effective tax rates and passing wealth to the next generation.
What is an FIC?
An FIC is a structure which enables growth in family wealth to be passed from one generation to another and also allows for the growth in family wealth to be protected. FICs are generally seen as more flexible than trusts, given that ownership can be changed and, with the right structuring, growth in wealth can be passed from generation to generation with minimal tax implications.
In its most simple form, parents will loan cash to a company which is owned wholly by their adult children. The cash is invested by the company, with the income and gains arising on the investments sheltered within the company and subject to corporation tax.
Given that the company is wholly owned by the adult children, the after-tax income will be attributable wholly to the shares held by them. The result is that the value of the estate which has been lent to the FIC will have been frozen for IHT purposes, and the parents can draw down on the loan to have funds to live on. The loan will, however, form part of the parents’ estate for IHT purposes.
It is also possible for the parents to contribute cash in consideration for shares in the FIC if they wish to retain voting rights in the FIC. However, depending on the type and rights attributable to the shares they hold, the shares could grow in value and mitigate some of the advantages of using an FIC as described above.
Taxation of FIC profits
An FIC is a corporate entity and will, therefore, be subject to corporation tax on its profits (currently at 19% but rising to a rate of 25% from 1 April 2023 with a marginal rate scheme for profits below £250,000). This lower tax rate allows for a greater proportion of profits to be re-invested, generating additional growth in the FIC.
In calculating the taxable profits, the FIC will be able to deduct charges incurred in the management of the investments and any interest on loans used to fund the investments made.
A point to note here is that excess management expenses and excess non-trade loan relationship debts (i.e. the interest expense) will be available to offset against capital gains made in the period or in future periods. If an individual were to be taxed on the gains, these offsets would not be possible.
In addition, the vast majority of dividends received by the company will not be subject to corporation tax by virtue of taking advantage of the exemption afforded by CTA 2009, ss 931A-931W. This differs for an individual who is taxed at income tax rates up to 38.1% on the receipt of a dividend.
Inheritance tax
In the simple example above, the loan to the FIC remained part of the parents’ estate. Under the inheritance tax (IHT) rules, it would be possible for the parents to gift the children the loan to the FIC as a potentially exempt transfer. For a period of seven years, this transfer would fall into the parents’ estate, albeit with a reduced rate of IHT if the parents had survived more than three years from the date of transfer. After the seven-year period has elapsed, the transfer would be tax-free, and the value of the parents’ estate would have been reduced by the amount of the transfer.
In the case where shares are given to the parents in consideration for the initial capital contribution, if the shares are subsequently gifted to the children, the gift is deemed to be a market value disposal for the parents, and any gains arising on the shares will be taxed on the parents. As the shares are in an investment company, it is not possible to use hold-over relief to mitigate the capital gains tax (CGT) arising. However, it may be possible to mitigate the CGT using some more complex tax planning methods.
FIC structure considerations
Generally, FICs are bespoke, with a unique set of articles and shareholder agreements set out to meet the needs for a specific set of family dynamics and criteria. When the initial structuring is taking place, it is generally advisable to have the input of a lawyer so that there are no adverse and unforeseen implications of the structuring.
Tied into this is ensuring that the shares in the FIC are protected in the event of divorce. A well-written shareholders’ agreement will usually ensure that the shares cannot be obtained by the non-family member; however, the value of the shares is likely to be considered during the divorce proceedings, with this value open to negotiation.
When getting assets into the FIC, care must be given to ensure that the transfers do not fall foul of the gift with reservation of benefit rules for IHT purposes, or the rules surrounding alphabet shares or value shifting. With careful planning and a full understanding of the outcome the family wants to achieve, it is generally possible to achieve the result without causing any unintended tax issues.
Have FICs been ‘blessed’?
In April 2019, HMRC set up a specialist FICs Unit. According to an HMRC spokesperson quoted by FTAdviser, the team’s purpose was ‘to look at FICs and do a quantitative and qualitative review into any tax risks associated with them with a focus on inheritance tax implications.’
In May 2021, the CIOT produced an email reporting their attendance at the Wealthy External Stakeholder Forum, at which a presentation was given on HMRC’s ‘Raising standards in the tax advice market’ consultation. One comment made during the presentation was that “the team have a better understanding of who uses FICs and found no evidence of a correlation with non-compliant behaviour. The team has concluded their work and, therefore, FICs will be considered as part of ‘business as usual’ rather than by the dedicated team.”
Although there has been no official word from HMRC of the closing of the specialist unit, CIOT’s comments are a good indication that HMRC will not be specifically targeting FICs, and the unit’s function has now been fulfilled. While tax professionals eagerly await HMRC’s next official update, we can expect clients’ interest in FICs to be anything but fixed.
Practical tip
To ensure the best outcome for a client, there should be a series of detailed conversations, exploring not only their wealth but also the family dynamic. An FIC may be a valuable tool for IHT and wealth structuring; however, there are a number of pitfalls if they are not set up properly, including unintended tax consequences or issues, should the family dynamic go sour.
