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Over the last decade or so, family investment companies (FICs) have become a popular vehicle for estate planning. Historically, trusts were always used for these purposes, but they are now subject to fairly penal tax charges and increased regulatory requirements.
FICs can be designed to mitigate the burden of inheritance tax (IHT) whilst enabling the ‘senior’ family members to obtain a degree of control over the family assets.
The increased corporation tax rate of 25% from 1 April 2023 has led some FIC shareholders to check the ongoing tax efficiency of their FICs. Many FICs are likely to be ‘close investment companies’ (CICs) (within CTA 2010, s 18N), and hence cannot benefit from the small profits or marginal rate relief. Exceptionally, property investment companies that mainly let properties to third parties should fall outside the CICs definition and would therefore use the 19% small profits rate if their taxable profits fall below the annual £50,000 limit (apportioned between ‘associated companies’).
It is useful to look at the overall effective tax rates for dividends drawn from an FIC in 2023/24. The table below assumes corporation tax at 25% under various scenarios:
Typical FIC structure
The structure and governance of an FIC will vary according to the objectives of the senior family members. The rights of the shareholders are normally set out in the FIC’s articles of association – this document will also stipulate that shares in the FIC can only be held by (defined) family members and family trusts.
The articles are filed at Companies House and are, therefore, in the public domain. Consequently, where confidentiality is required about the arrangements dealing with members’ rights and obligations, a suitable (private) shareholders’ agreement can be drawn up.
A typical FIC structure is outlined below:
The parents will normally hold all the ‘A ordinary shares’, which will carry the right to appoint directors and vote at general meetings. These rights effectively enable the parents to retain control over the company’s assets. The parents might want to consider appointing one or more additional directors (who they would trust to act in the children’s best interests). The directors, therefore, act in much the same way as trustees of a trust would.
The ‘A’ shares may also have the right to distributions but often have no right to capital.
The (adult) children (or other close family members) would hold the ‘B ordinary shares’. In the majority of cases, the B shares would have no voting rights or other ‘control’ rights. The B shares would have entitlement to dividends and capital rights (but these would be subject to the parents’ effective approval via the ‘control’ mechanism vested in the A ordinary shares).
To avoid the impact of the parental settlement rules (in ITTOIA 2005, s 629), the children should only take dividends after they have reached their 18th birthday.
The parents’ loan accounts are normally interest-free and are often gradually repaid to finance their day-to-day living expenditure. The value of the loan accounts would reduce over time, thus decreasing the size of the parents’ chargeable estate for IHT purposes. Furthermore, a number of years down the line, having assessed their own personal and financial needs, the parents may wish to gift all or some of their loan account to their children. This can generally be arranged without any materially adverse IHT or CGT issues.
The company would make suitable investments – such as property, shares, unit trusts, etc. The income or profits can be used to repay the parents’ loan accounts, or be reinvested, or may be used to pay appropriate dividends to the children.
The value of the FIC’s shares will often be minimal at the outset (especially where the FIC is highly geared as a result of the loan accounts). Consequently, there is unlikely to be any material IHT exposure by placing a suitable amount of (say) B ordinary shares into a discretionary trust. Similarly, gifting shares directly to the children by means of a potentially exempt transfer (PET) should not give rise to meaningful IHT or CGT costs.
Transferring assets to the FIC
An FIC will frequently be set up as a UK-registered limited company. Sometimes, an existing company may deliberately switch to an FIC – for example, after selling or ceasing its trading activities.
In many cases, the senior family members make initial loans to the FIC. In some cases, existing properties or other investments may be sold to the FIC, with the proceeds being left outstanding on the loan account. The sale of properties and other investments to the FIC may give rise to a CGT liability. The transfer of a family property rental business (in England) may also trigger an SDLT charge (based on the market value of the relevant properties), although it may be possible to avoid this SDLT charge if the transfer is made from a genuine partnership or LLP if the transaction can be brought within the special rules in FA 2003, Sch 15A, paras 18-20.
Some families prefer to use an unlimited company. Such companies do not have to file company accounts with Companies House and have other legal relaxations. Given the low risk normally attached to the company’s investment activities, the shareholders might consider that privacy benefits outweigh their potential exposure to personal liability.
FICs generally compare favourably with trusts, which will often incur a 20% ‘up-front’ IHT liability where the assets transferred to the trust do not qualify for 100% IHT business relief and the amount transferred exceeds the transferor’s available nil-rate band. On the other hand, FICs do not generally offer the same degree of asset protection in divorce cases as compared with discretionary trusts. However, the potential vulnerability of FICs in divorce cases could be mitigated by a suitable trust holding some of the FIC shares.
Potential benefits of FICs
Despite the increase in corporation tax rates, the tax paid on an FIC’s taxable income and gains still compares favourably with the tax rates suffered under personal ownership or by discretionary trusts. Importantly, an FIC’s dividend income is invariably exempt from tax (under CTA 2009, Pt 9A). FICs work best where the income is retained by the company over a long-term period (rather than being paid out to the shareholders).
While an FIC may give rise to an element of ‘double tax’, this can be managed by carefully calibrating the timing and the amount of dividend paid out to the children etc.
In summary, FICs continue to play a very useful and tax-efficient role in family estate planning. They are reasonably flexible structures and can be designed to suit each family’s particular dynamics and requirements.
Practical tip
By careful structuring, the capital growth of an FIC will accrue outside the parents’ estates for the benefit of the children in an ‘IHT-friendly’ way.