Incorporating FICs should be considered a strategic component of inheritance, succession, and wealth planning.
Let us consider a scenario where parents desire to transfer their wealth to their young children while ensuring that the children do not have unrestricted access to the funds at a young age.
Traditionally, Trusts have been a common choice, but they can be legally complex and may not always offer optimal tax efficiency. Many business-minded individuals are familiar with the concept and operation of a limited liability company, which is one of the key advantages of a family investment company. Furthermore, FICs offer a high level of flexibility, allowing them to be tailored to the specific circumstances and requirements of each family.
What is a Family Investment Company?
A Family Investment Company (FIC) is a privately owned company that is established with the purpose of effectively managing and safeguarding its wealth, as well as potentially transferring it to future generations through shares in the company.
This structure allows for the older generations to maintain control over the assets while also facilitating the transfer of value to younger generations, all while avoiding immediate inheritance tax (IHT) charges.
FICs could employ various types of shares, each carrying different voting and economic rights concerning the distribution of profits or assets if the FIC were to be wound up. Funding for FICs can be accomplished by subscribing to shares with cash or other assets or by utilising debt such as interest-free loans. It is also common to combine equity and debt to finance an FIC.
functioning mechanism of family investment companies
A family investment company functions through the founders transferring cash and non-cash assets into the company in exchange for shares and loans. While the transfer of non-cash assets may attract tax liabilities, the shares can be gifted to family members without incurring inheritance tax if the donor survives for seven years.
The parents hold A-shares with voting rights but no entitlement to dividends, while the children hold B-shares with dividend entitlements, subject to parental approval. The company is funded through loans, and it acquires various assets that generate income, which can be reinvested or used to repay the loans. The underlying capital growth occurs in the children's names.
Family investment companies involve the founders’ transferring assets to a company in exchange for shares and loans. The shares can be gifted to family members without immediate tax consequences if the donor survives for seven years.
The parents retain voting rights but no dividend entitlement, while the children hold shares with dividend rights. The company is funded through loans, acquires income-generating assets, and experiences capital growth in the children's names.
Family Investment Companies Tax Implication
1. Inheritance Tax
If the parents successfully adhere to the typical seven-year rule, a Family Investment Company (FIC) can offer various tax-efficient strategies concerning inheritance tax.
2. Corporation Tax
For Family Investment Companies (FICs), the applicable corporation tax rate depends on their annual profits.
If the FIC's annual profits are below £50,000, it will be subject to a small profit rate of 19% for corporation tax. On the other hand, if the annual profits exceed £250,000, the corporation tax rate for the FIC will be 25%. In cases where the profits fall between £50,000 and £250,000, marginal relief provisions will be implemented to bridge the gap between the two tax rates.
3. Relief on Corporation Tax
A Family Investment Company (FIC) has the advantage of being able to claim a deduction for corporation tax on bank charges and interest incurred from loans obtained against the value of its investments.
These loans must be utilised for the business purposes of the company. This provides a benefit over individuals who are unable to claim tax relief on loan interest.
4. Capital Gains Tax
Proper planning can help avoid capital gains tax when establishing a Family Investment Company (FIC). However, any future disposals by the FIC will be subject to standard corporation tax rates.
The availability of an indexation allowance can reduce the taxable gain on assets held before 1 January 2018. It's important to note that while transferring assets into an FIC may result in capital gains tax for the transferor, it can be more beneficial for the FIC to acquire assets using loan funding.
5. Tax on Dividends
Dividends received by the Family Investment Company (FIC) are exempt from tax. However, there is a tax obligation on dividends paid by the FIC to its shareholders.
Fortunately, there is a threshold exemption limit of £1,000, which means dividends up to this amount can be tax-free. Any dividends exceeding this threshold will be subject to a starting rate of 8.75%, which mitigates the potential tax burden. It is worth noting that even the highest rate of dividend tax is lower than the current 45% rate applied to trusts.
6. Taxation for Shareholder
When the Family Investment Company (FIC) distributes dividends, the tax implications for shareholders will vary depending on their individual circumstances. If the dividend payment exceeds the dividend tax allowance (£1,000 in 2023-24), the tax rate will depend on the relevant tax band.
For those in the basic rate tax band, the tax charge will be 8.75%. For individuals in the higher rate band, it will be 33.75%, and for those in the additional rate band, it will be 39.35%. It's important to note that smaller payments to younger adult shareholders may potentially be tax-free.
Creating or Setting Up a Family Investment Company
The structure, planning, and strategy of a Family Investment Company (FIC) will differ based on the specific circumstances of the founders and owners.
However, establishing a FIC typically involves taking the following factors into consideration:
Managing a Family Investment Company
In a Family Investment Company (FIC), the owner/founder serves as the director and makes decisions, while other shareholders benefit financially.
The company acquires assets, generates income, and grows in value for future generations. Management practices depend on customised agreements tailored to the founder and family's needs. It will mainly depend on the articles of association and shareholder’s agreements drawn up for the said company.
We've compiled a thorough guide on 'How to Set up and Manage Family Investment Companies' that can serve as your go-to resource for this process.
Benefits of Family Investment Companies
Family Investment Companies (FICs) present various benefits for individuals and families aiming to effectively manage and safeguard their wealth. These structures offer advantages such as increased control, adaptable nature, and opportunities for tax planning.
Establishing a Family Investment Company (FIC) offers numerous advantages for individuals and families seeking to manage and preserve their wealth. FICs provide opportunities for tax savings through lower corporation tax rates on profits and potential inheritance tax benefits. Dividends received by the FIC are tax-free, and income can accumulate within the company without immediate taxation. The corporate structure of FICs also offers protection in the event of divorce, safeguarding assets from being divided.
Furthermore, FICs allow for asset protection by separating personal and business assets, minimising risks associated with business activities or creditor claims. Families can retain control over their assets and involve multiple generations in decision-making processes, ensuring the preservation of wealth and values. FICs also facilitate structured succession planning, allowing for a smooth transfer of wealth and legacy to future generations.
Drawbacks of Family Investment Companies
While Family Investment Companies (FICs) offer advantages, there are important considerations to keep in mind. Paying out all profits can lead to double taxation, making it more tax-efficient to retain profits within the company.
Transferring assets other than cash can trigger tax charges, and the administrative and ongoing costs of running a FIC can be significant. FICs are not suitable for families needing regular income and can potentially create conflicts among family members. Furthermore, privacy may be compromised due to disclosure and reporting requirements. It's essential to weigh these factors when considering the establishment of a FIC.
When considering whether a family investment company is right for you, our detailed analysis of the 'Pros and Cons of Family Investment Companies' can provide you with valuable insights.
Examples of Family Investment Companies for Wealth Management
Understanding the practical application of Family Investment Companies (FICs) can be crucial in effective wealth management.
Below, we delve into real-world scenarios that illustrate how FICs can be utilised for efficient asset distribution and tax planning.
For example,
Let's assume you have a surplus cash amount of £10 million along with other assets, and you want to distribute it equally among your four family members. However, due to their young age and concerns about potential future complications like bad marriages or divorce, you hesitate to pass on the cash immediately. If you were to do nothing and pass away, HMRC would collect £4 million in inheritance tax (IHT) on the £10 million, leaving your family members with only £1.5 million each, making HMRC the primary beneficiary.
To address these concerns, one option is to establish a Family Investment Company (FIC). In this scenario, you can subscribe for £200,000 of A voting shares and £9,800,000 of non-voting B shares. Subsequently, you can gift the B shares to your family members. As long as you survive for at least seven years following the gift, these transfers would be exempt from IHT. It is crucial to make these gifts before the company's value increases to avoid potential capital gains tax implications.
By setting up the FIC, you would gain control of a company with £10 million in cash. This cash can be used to acquire other investment assets or earn interest. This approach provides a structure where you can retain control over the cash while safeguarding against immediate IHT and potential future complications, allowing you to pass on the assets to your family members in a tax-efficient manner.
Conclusion
When assets are gifted to a Family Investment Company (FIC), there is a potential exemption from inheritance tax, but if the parents pass away within seven years, there could be tax implications. To avoid this, it is more common to transfer investment assets at market value and keep the purchase price as an outstanding loan, eliminating the gift and potential inheritance tax charge.
Transferring assets into an FIC may incur capital gains tax on the disposal of those assets. However, by structuring the transfer as a loan, parents can receive tax-free payments as loan repayments from the FIC.
Overall, setting up an FIC in this way allows for future growth in asset value to be outside the parents' estates for inheritance tax purposes. Additionally, any income generated by the assets can be received by the parents as loan repayments without additional tax charges.
This approach enables the preservation of both future asset growth and income while potentially reducing inheritance tax liabilities.
How UK Property Accountants can help?
If you and your family are considering the utilisation of a Family Investment Company (FIC), our team of tax experts is ready to assist you. UK Property Accountant’s expertise in tax planning and structuring enables us to optimise tax strategies, ensuring compliance and maximising tax efficiency for the Family Investment Company (FIC).
With our guidance, the FIC can navigate complex tax laws and regulations, minimising the risk of penalties or legal issues. By leveraging our specialised knowledge and experience, the FIC can confidently navigate the intricacies of the tax landscape, maximising financial advantages and contributing to the overall success of the family's investment endeavours. We are dedicated to gaining a comprehensive understanding of your unique circumstances and providing guidance on the most effective and tax-efficient strategies for managing and transferring your wealth.
For more information, please contact us through our usual UK Property Accountants enquiry form.
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