The tax benefits of Family Investment Companies
What is a Family Investment Company?
A Family Investment Company is a private limited company where family members hold shares. Unlike trusts, FICs offer a more direct control over assets, whilst providing a formal structure for managing investments. These companies are typically limited by shares, and the shareholdings are distributed among family members, often spanning multiple generations.
If you are interested in tax-efficient growth or asset protection, you can potentially fund a Family Investment Company, which then acquires investments in its own legal right.
Non-tax benefits of Family Investment Companies
The non-tax benefits of Family Investment Companies means they can be both flexible and strategic. Their structure typically involves the following:
The traditional approach to family wealth management has historically revolved around trusts or direct ownership. However, FICs can potentially offer significant tax advantages, particularly in terms of Income Tax, Capital Gains Tax, and Inheritance Tax which we'll discuss later on in this article.
In recent years, the UK has seen a rise in the use of FICs, primarily due to their tax efficiency and the tightening of trust regulations. If you hold significant assets, FICs present an opportunity to manage wealth in a way that aligns with your long-term financial goals and tax planning strategies.
The tax benefits of Family Investment Companies
Overview
Many FICs fall into the description of a Close Investment Holding Company. This means with effect from 1 April 2023 they will be taxed at the main rate of corporation tax of 25% regardless of the level of their profits.
When used as a genuine family wealth wrapper, it is also possible to gradually shift control of the company over time and thus the family wealth to the next generation with associated Inheritance Tax benefits.
Income tax
Companies are generally exempt from paying tax on the receipt dividend income themselves. Any interest or rental income will be taxable at the corporate tax rate of 25% as opposed to say 40%/45% if received as an individual.
FICs can distribute profits to shareholders in the form of dividends and shareholders can be allocated different classes of shares. This allows for a flexible distribution of dividends. This can be particularly advantageous for utilising lower tax bands of various family members.
One drawback is the potential for a double tax charge when it comes to extracting profits from a company. This is not an issue where the company is receiving mainly dividend income. If it is in receipt of taxable rental income, it could be taxed both when it goes into the company, and when it is extracted.
For this reason, a FIC is usually not recommended if there is a need for the profits to be extracted by anyone other than a basic rate taxpayer in the short to medium term.
Capital Gains Tax
Companies are charged to Corporation Tax on gains. There is also no annual exempt amount; Indexation relief is still available to companies though it is frozen at 31 December 2017 for any disposal from 1 January 2018.
Inheritance tax
If the FIC's activities are wholly or mainly those of holding investments, the value of its shares held at death will be included in their owner's estate.
This may be mitigated by passing shares down over time, by careful structuring of the initial shareholdings or by investing in assets that will qualify for Business Property Relief. One such example are shares in AIM listed companies. Minority shareholdings are discounted in value for IHT (due to lack of marketability) which may be very advantageous.
Unlike Trusts, there are no 10-year anniversary or Exit charges with a FIC and running costs may be less expensive than for a Trust
Setting up a Family Investment Company
An FIC may be run in tandem to and receive funding from existing trading companies. If at all possible you should make the initial funding with cash. This should hopefully avoid triggering any latent capital gains.
If this is not possible, try to use any assets standing at a loss to mitigate any chargeable gains or transfer assets gradually over time to maximise the use of available Capital Gains Tax annual exemptions.
Creating new share classes
If a company is being set up from scratch it is easy to create different share classes with different rights, as applicable, on incorporation.
Changing share rights is not difficult but if an existing company is being adapted to be used as a FIC, there is a potential CGT issue if the company already has value and there is a desire to transfer shares to adult children for example (see notes below about the Settlement rules and minor children). It may be possible to create new class of share known as 'Growth shares' which side steps this issue and we'll cover these in a separate article.
Passing on a FIC to the next generation
If you are an individual shareholder of a FIC you will need to plan carefully in order to pass on your shares. This is because investment company shares do not qualify for the same Capital Gains and Inheritance Tax holdover reliefs that are potentially available for shares in a trading company.
Summary
The tax advantages of Family Investment Companies in the UK are compelling. They offer a versatile and efficient means of managing family wealth, with considerable benefits.
However each FIC will need be tailored to your particular circumstances and so it is not recommended to simply use an off-the-shelf structure.
Whilst presented as an alternative to a trust, it is likely that including a Trust in a FIC structure is desirable up to the point that it can be funded without triggering a tax charge, as a trust can still be tax-efficient. The double layering of trust/corporation adds an additional level of security to the assets though it may also increase costs.
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