How the Family Investment Company can save you Inheritance Tax
Budget announcements on 30 October 2024, and the subsequent BPR/APR impact, have meant that individuals and family businesses are considering alternative ways to save Inheritance Tax (IHT).
Liam Coulter, Tax Director at Wilson Nesbitt, explains how a Family Investment Company works, how it compares to using a trust, and how it could save you IHT.
What is a Family Investment Company?
A Family Investment Company (FIC) is a UK resident private company whose shareholders are usually entirely made up of family members.
Typically, they are set up by older generations wishing to protect family assets and transfer wealth to future generations.
How Does a Family Investment Company Work?
Cash Option
The founders transfer cash into the company in exchange for a combination of shares and loans.
The founder can then gift shares of the company to other family members as a Potentially Exempt Transfer (PET). Therefore, there would be no inheritance tax consequences for the donor if they survive seven years following the date of the gift.
Assuming the gift occurs soon after the creation of the company, there are no capital gains tax concerns for the donor.
Asset Option
The founders have assets, not cash. They create a company and sell assets to the company, funded by a loan the founders make to the company. The founders then assign their loans to family members to start the seven-year clock. In this scenario, capital gains tax and stamp duty land tax issues will need to be considered.
What are the Tax Benefits of a Family Investment Company?
Corporation Tax
As a corporate entity, the FIC will usually pay corporation tax at 25%. This is significantly lower than the top rates of personal income tax (40%/45%). Having paid the 25% corporation tax, assigned loans under the asset option can then be repaid without tax to the recipients.
A FIC can hold investments such as shares and property. Dividend income received from shares by a company is usually tax-free.
Rental income received on investment property will be taxed at the corporation tax rate shown above, with the added benefit that companies can still deduct loan interest from the rental income.
If a FIC solely receives dividend income, there would be no corporation tax payable.
Income Tax
The purpose of the FIC is to accumulate family wealth in a tax-efficient manner rather than to maximise and pay out income. Therefore, the longer the returns are held in the FIC, the better.
When returns are taken out of the FIC, they can be taxable in the hands of the shareholders. Dividends received by the shareholders are taxed at the dividend tax rates (8.75%/33.75%/39.35%, subject to the personal allowance exemption).
If loans are repaid by the FIC, these are tax-free, although interest received on the loan capital is subject to income tax.
There are ways to mitigate income tax depending on how returns are distributed to family members. Advice should be taken on different scenarios to extract returns in the most tax-efficient manner.
Capital Gains Tax
If the FIC sells any of its assets, the gains are included in the corporation tax return and taxed at the corporation tax rate (usually 25%), while if the FIC is wound up (assuming a members’ voluntary liquidation), the shareholders pay capital gains tax (currently 24%) on the value of the assets distributed to them.
Alternatively, if the FIC is sold by way of a share sale, this too is a capital event, and the consideration received for the sale of the shares is taxed at 24%.
Finally, if the FIC is a trading company, Business Asset Disposal Relief may be available for both winding up and share sales, subject to the new rates effective over the next two years.
Inheritance Tax
As mentioned above, if properly structured, assets transferred to or loaned to a FIC will not generate an upfront Inheritance Tax charge – a key difference between FICs and trusts.
Assets held in FICs are usually “investments” and do not attract relief for inheritance tax purposes. However, FICs can effectively plan for inheritance tax, as value can be passed to future generations through the creation of new share classes for their benefit.
Gifts to the next generation would be subject to the usual seven-year PET rules and would fall out of the donor’s estate if they survive seven years from the date of the gift.
FICs also allow directors to retain control over the gifted shares, which is often helpful in estate planning.
How Does a Family Investment Company Compare to Using a Trust
A FIC can operate in a very similar way to a trust. A typical FIC will have the founding generation (akin to the settlor and trustees) retaining controlling rights over the assets that the company owns. These controlling rights may arise from specific terms in the Articles of the company or from rights attached to a class of shares.
A typical trust will have beneficiaries who benefit from the income that the trust generates, who are different from the people who control the assets. The FIC mirrors this by issuing classes of shares with different income rights or voting rights to different individuals. This allows the income that the FIC generates to be distributed to those individuals in accordance with the overall wishes of the family.
Inheritance Tax on Creation
A FIC can be set up without triggering an immediate lifetime IHT charge. By contrast, transferring assets to a trust (in excess of the IHT nil-rate band allowance of up to £325,000 per person) can result in an immediate lifetime IHT charge at 20% and may still result in a further IHT charge if the settlor dies within seven years.
Ongoing IHT Charges
Discretionary trusts are subject to ten-yearly IHT charges at a rate of up to 6% and proportionate charges on capital distributions when assets exit the trust. FICs are not.
Capital Growth
The class of shares issued to the founders often has limited rights to capital, ensuring that the growth in the value of the FIC is attributable to other family members’ shares and outside the founders’ estates, thus saving the founders IHT.
What Are the Downsides to Using a Family Investment Company?
Cost
It costs more to set up a FIC than a trust. Setting up a FIC is a more involved process, requiring professional advice from private wealth, corporate solicitors, and tax specialists.
Capital Gains Tax on Creation
If a FIC is funded by transferring non-cash assets, there may be capital gains tax payable. In contrast, when transferring assets to trustees, the settlor may have the option to claim holdover relief and defer CGT.
Double Taxation of Income
A FIC is an efficient vehicle for accumulating profit, but if distributing those profits to shareholders by way of dividends, there is an element of double taxation. Corporation tax is charged on (non-dividend) profits, and income tax is charged on the dividends paid to the shareholders.
If the main objective is to accumulate value within the FIC, this can be done efficiently and may outweigh the impact of double taxation in the long run.
Who Can Benefit
A FIC can only distribute money to its shareholders. By contrast, discretionary trusts can have relatively wide classes of beneficiaries.
Example
You have surplus cash of £5 million and want to distribute this to your family. You have the usual concerns about giving away large amounts, such as bad marriages, divorce, age-related immaturity, etc., so you do nothing and sadly pass away. HMRC will collect IHT at 40%, resulting in an estimated £2 million liability.
If you establish a FIC, subscribing for £100,000 of A voting shares and £4,900,000 non-voting B shares, these B shares can immediately be gifted to family members (avoiding CGT as there is no increase in the share value due to the quick turnaround).
As long as you survive at least 7 years, £4.9 million falls out of your estate, saving almost £2 million in IHT.
You, therefore have control of a company with £5 million in cash. This cash is used to purchase investments that only produce dividend income. The company does not pay any corporation tax on this dividend income, as it is exempt.
This approach means you retain control over the company but have no rights to income or capital. In contrast, the family members will have all the rights to income but no voting rights.
You decide to pay some family members a dividend. This can be structured so that the family member pays income tax on the dividend at the lower 8.75% rate.
The shares held in the FIC will not benefit from business property relief (as the company is an investment company, not a trading company). However, for inheritance tax purposes, shares gifted during a lifetime will be treated as potentially exempt transfers (PETs) and will escape an IHT charge if you survive seven years. As time passes, you and family members could pass shares down to future generations and potentially save IHT.
Summary
Generally, trusts lend themselves to smaller funds or IHT-relieved assets where flexibility and asset protection are key aims. Trusts are also useful when access to assets may be necessary in the short term.
FICs tend to be recommended for those with a very significant exposure to IHT, large cash or capital deposits, long-term generational wealth planning, and those who are more familiar with running companies.
Trusts were traditionally seen as the best way to achieve clients’ IHT objectives, despite the increased tax costs and greater running costs. However, depending on a client’s assets, overall wealth, family circumstances, and objectives, FICs can compare very favourably with trusts.
With the ability to transfer limitless assets into a FIC without an IHT cost, FICs can be a very effective IHT planning structure, providing both control and flexibility.
Ultimately, the decision to establish a Family Investment Company should be carefully weighed, considering the specific needs, goals, and circumstances of the family, and should be made in consultation with legal, tax, and financial professionals. Our experienced tax and legal team here at Wilson Nesbitt is here to help and can guide you through the FIC process.
To chat to one of our team members about how a Family Investment Company may be the ideal solution for you, please contact us here.