Family Investment Companies
The recent U-turn by UK Chancellor Kwasi Kwarteng on abolishing the 45% top rate of UK Income Tax, and confirmation that the rate of Corporation Tax will remain at 19%, reinforces the stark contrast between personal and corporate tax rates in the UK. Tax is one of the reasons that individuals are increasingly looking at companies as vehicles for holding family wealth. This article examines tax and some of the other reasons for setting up ‘family investment companies’ (“FICs“) as well as mentioning other structuring ideas clients may consider.
Why set up a FIC and how does it work?
A FIC can be a very useful vehicle for holding and accumulating investments in a tax efficient manner for clients who are already, or are shortly to become, subject to UK tax (eg because they are UK tax resident or they have UK property income). Unlike some other investment vehicles, there is no limit to the type of assets a FIC can hold and a FIC can borrow money. A FIC affords limited liability against any losses and it can also be used to operate business activities through. A FIC may also be able to run a company pension scheme in conjunction with family members employed in the business. One or more companies can be used to segregate different assets or activities, if need be, and it may be possible to convert an existing company into a FIC by amending the company’s constitution.
If the family is not worried about limited liability, then a FIC can be set up as an unlimited company in order to limit the need to file accounts publicly – this may be of interest to some families for whom confidentiality about their detailed affairs is particularly important. Many FICs will be ‘small companies’ for accounting purposes, in which case limited accounts need to be filed anyway.
Non-UK clients may consider using a non-UK company as a FIC depending on the nature of assets held, although a UK company is usually the most appropriate option for UK clients or where the assets comprise only UK residential property; a reminder that only property that is 100% commercially let out should be held through a company for various UK tax reasons.
A FIC can be used to facilitate succession planning – by giving shares to family members either immediately or in the future. However, the founder of the company can maintain control if desired; the articles of the company can be custom drafted to suit the exact needs of the family. For example, the founder may retain voting rights over the shares thereby controlling the board of directors – and they can be one or all of the directors initially. The founder’s children can be given non-voting shares which either have current value or only future growth – perhaps only kicking in above a certain valuation hurdle.
Dividends can be streamed to particular shareholders through ‘alphabet shares’. Funding might be by way of shareholder loan or subscription for share capital – shareholder loan funding may enable the founder to extract funds from the company tax efficiently if the shareholder loan is interest free.
There is of course likely to be a cost to setting up a FIC; as always, the best planning is bespoke and undertaken with the benefit of expert advice and drafting. However, once the initial set up work is done, the extra cost of running a FIC compared to personal ownership of assets should be fairly limited. Overall, a FIC is likely to be more cost effective to run than many other investment holding vehicles.
How is a FIC Taxed?
Tax at company level – capital gains made by the company will be taxed at 19% rather than personal Capital Gains Tax rates at up to 28%. Dividends received by a FIC are likely to be tax free; other income (eg interest and rental income) will be taxable at the 19% Corporation Tax rate. There is scope for deducting some management expenses, unlike personal ownership, and unlimited interest deductions on property financing which are capped for individuals.
Extraction of funds – It may be possible to extract funds from the company entirely tax free to the extent of any shareholder loan. Otherwise, dividends can be declared; for UK tax residents, these will be subject to tax at between 0% and 38.1% depending on the shareholder’s marginal rate of tax and availability of personal allowance.
Inheritance Tax – If ordinary shares, and/or some of the shareholder loan, are gifted on formation of the FIC then this will reduce the value of the founder’s estate for IHT; IHT will only be payable on this gift if the founder fails to survive the gift by 7 years, and this can be insured against. Alternatively, or in addition, ‘growth’ shares can be used to gradually shift value to the next generation without the 7 year rule applying. FICs are not subject to the 10 year anniversary charge, unlike some trusts.
HMRC recently reviewed the use of FICs generally – they have now closed their investigation into them having concluded that they are not being abused for unreasonable tax avoidance, so FICs can be approached with some confidence, as long as implemented properly.
Alternatives to FICs
The best tax and estate planning is done in conjunction with your Independent Financial Adviser with the support of other professionals as needed; they can guide you through all the options and make sure that you fully understand the implications for you and your family. One option is not to worry about tax planning at all – still the minority view fortunately for advisers! Other structuring and tax planning ideas which you might consider in addition to FICs include the following:
Trusts – trusts can be set up by transferring assets to trustees as legal owners to hold for beneficiaries or simply by declaring yourselves as trustees for beneficiaries subject to the terms of a trust deed. A flexible or discretionary trust enables the trustees to decide if and when to make benefits available to beneficiaries. Gifts into most forms of trust over the IHT nil rate band of £325,000 GBP triggers a 20% lifetime tax – this applies to any ‘UK domiciled’ individuals, including most expats. However, trusts worth up to £650,000 per married couple can be made every 7 years without an immediate IHT charge – apart from at 10 year anniversaries at up to 6% on any growth. Over say 20 years this can enable a significant value to be held outside the taxpayer’s estate for IHT.
Lifetime Giving – If a person who makes a complete gift survives the gift for at least 7 years then there will be no IHT payable. Furthermore, if death occurs between 3 and 7 years from the gift the IHT rate is reduced. It will usually be quite cost effective to ensure the donor’s life for this period to cover the IHT of failing to survive the full 7 years. One downside of straight gifting of property is that, once gifted, there is no control over the assets which then become subject to possible creditor\ divorce claims against the recipient.
Insurance Bonds – An offshore insurance bond can be used as a wrapper for financial assets which grow tax free. UK residents can withdraw up to 5% of the original premium each year tax free and this amount aggregates every year if not fully taken – up to 100% of the original premium after 20 years. There are various tax reductions against ultimate Income Tax on withdrawals over the 5% e.g., non-resident apportionment and ‘top slicing relief ‘ for basic rate taxpayers. The choice of investments which a bond may hold for a UK resident is limited compared to a FIC. An insurance bond can be coupled with a ‘Discounted Gift Trust’ for IHT planning; this enables the client to receive a fixed amount or percentage return from the bond for the rest of their life but with the bond belonging to a discretionary or fixed interest trust for the next generation so that, after 7 years, the value of the trust is outside the client’s estate altogether.
Michael Evans & Jos Style
Foot Anstey is a sizeable UK-based law firm with seven offices and an extensive international network of best friend law firms. This enables us to assist clients on any matter in the UK or abroad.