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Is a family investment company tax efficient?

18 October 2021
Jan Friend
Property Owners, Reducing Tax, Estate Planning / IHT

Family investment companies (FICs) have become increasingly popular in the last few years. We have seen many of our clients set them up to start a process of passing assets down the generations as part of a tax planning and tax minimisation strategy. They can be used where parents or grandparents have cash, property or stocks and shares that they identify as assets they would eventually like to pass on as lifetime gifts – even if in the short to medium term they still want to benefit from the income.

What is a family investment company?

So the first thing to establish is what actually is a family investment company? It is essentially a private company set up with the aim to preserve family wealth. Usually the shareholders will be various generations of the family, with the oldest generation keeping control.

The good news is that a unit formed by HMRC to investigate links between FICs and tax avoidance has recently been disbanded because no evidence was found that FICs were being used as a tax avoidance vehicle. That means that for the time being at least we can continue to advocate the use of these companies as part of family estate planning.

An FIC can be used as an alternative to a trust, and it has the advantage of allowing the company assets to be divided more easily through different amounts and classes of shares than is practical distributing fractional entitlements of assets through a trust structure.

An FIC is treated the same as any other company with regard to compliance issues. So it will need to submit annual accounts and tax returns to HMRC and will need to pay annual corporation tax on its profits. It will also need to be registered with Companies House, will appoint directors, provide articles and a memorandum of association, file annual accounts and disclose details of persons with significant control.

What are the important factors to consider when setting up a family investment company?

There are many different factors that should be taken into account when setting up an FIC. The most important one is to identify the future recipients, but other factors such as grandchildren, divorce and death should not be overlooked.

Usually the express purpose of FICs is to minimise tax and preserve wealth for the family unit. We would therefore recommend that bespoke articles of association are used and that there is a shareholders’ agreement in place. That should ensure that the correct rights and controls of the shareholders are properly set up and documented.

Express provisions can be put into place to restrict the transfer of shares, or prevent the amendment of the rights to income and/or capital of the various share classes. They can also include restrictions for events which would trigger a compulsory share transfer, such as in the event of divorce or death. The articles of association can include a drag on provisions (enabling a majority shareholder to force a minority shareholder to join in the sale of the company) and deadlock provisions to further safeguard the family wealth.

The share structure needs to be considered carefully to make sure that it reflects the individual needs of the family members and keeps control of the company with the parents or founding members. We would always consider the individual personal tax position of each family member to ensure the most tax efficient split of shares for income purposes.

When would you use a family investment company?

An FIC is a perfect vehicle to consider when you are seeking advice regarding future succession planning. Trusts can also be excellent vehicles for succession planning and should certainly be considered seriously. However an FIC can be more appealing, particularly to those that come from a corporate or entrepreneurial background. That is because they are already familiar dealing with companies from an administrative and legal perspective.

In practice parents usually inject cash or assets into the company and then gift non-voting shares to their children, who then become shareholders of the company. Quite often we use different classes of shares with different rights. The advantage of that structure is that dividends can be paid out in whatever amount is agreed by the controlling shareholders, rather than being restricted to the percentage of shares held. That means by way of example use can be made of one child’s basic rate band without forcing another child to pay additional tax on the same dividend.

How are family investment companies taxed?

The transfer of cash into the company does not carry any tax consequences. If you transfer assets, such as shares or property, there will potentially be capital gains tax (CGT) and possibly stamp duty to pay. You should always seek professional advice before embarking on any tax saving structure.

The initial gift of shares from parent to child will be a potentially exempt transfer (PET) for inheritance tax (IHT) purposes. That means there is no IHT payable immediately and if the donor survives seven years from the date of gift there would be no tax payable at all. If you compare this with using a trust, gifts of assets into trust are chargeable lifetime transfers. Therefore if the value exceeds £325,000 there is an immediate IHT liability of 20% of the excess.

From a CGT angle the gift of shares would be a chargeable disposal, but provided the gift is made before there is any growth in investment value no tax would be due.

Disposals of assets within the corporate veil would be liable to corporation tax on chargeable gains. The current corporation tax rate is 19%. This will increase to 25% from 1 April 2023 for investment companies. However trading companies and property rental companies will only start to pay the higher rate for profits over £50,000.

Any income extracted from the company would usually be in the form of dividends and taxable on the recipient in the normal way. Each taxpayer has a £2,000 dividend allowance. Above that dividends are taxed at either 7.5%, 32.5% and 38.1%, depending on whether the top part of your income falls to be taxed at basic rate, higher rate or additional rate. These tax rates will increase from 6 April 2022 to 8.75%, 33.75% and 39.35%. By careful tax planning we can make sure to minimise the tax liabilities across the family group. An example of this is where the initial funds are provided by the grandparents any dividends on shares allocated to grandchildren will not be taxed on their parents. That way the £2,000 allowance can be spread widely among the family group.

One potential advantage to the company founders is that they will usually inject cash or assets into the company by way of a loan. That means the loan is available to draw down without any tax consequences if they do need extra income or capital, subject to company liquidity of course. In addition the founders can charge the company interest on the loan, which can make use of the generous savings allowances available. This tax planning step is not relevant to all taxpayers as it depends on the make up of your other sources of income. Again dedicated tax advice is essential.

What should I do next?

You will see from the information above that there is a lot to consider before deciding to set up a family investment company. That is why it is imperative that you seek bespoke tax planning for your personal circumstances. If you are interested in how we can help reduce your taxes contact Jan Friend.

The content in this blog is correct as at 18 October 2021 See terms and conditions.

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