Family Investment Companies For Succession And Tax Planning

Historically trusts have been used as a tax-efficient vehicle to pass assets to the next generation. For many the ability to retain control of the assets whilst also protecting them from a potential divorce of the next generation is attractive. However, trusts come with their own complexities and tax rules. In particular, the potential inheritance tax (IHT) charge on the creation of a trust as well as high-income tax rates can make trusts prohibitive. Increasingly we are advising clients on using family investment companies (FICs) as an alternative to trusts. FICs will never be as flexible as trusts but the ability to retain income and capital in a tax-efficient manner has meant FICs have grown in popularity.

It is important that both options are considered for passing family wealth between generations and the most appropriate vehicle is used based on the individual circumstances and objectives. The key considerations of each are summarised below:

Trusts

1. Creation

On creation of a trust the settlor (an individual) transfers cash or an asset into trust. This is a chargeable transfer for IHT purposes. Therefore, if the value of the asset, after reliefs, is worth more than the nil-rate band (currently £325K), an IHT charge at 20% will arise. For example, a husband and wife can contribute up to £650K of value before any IHT will arise

The transfer will also be chargeable to capital gains tax (CGT) but holdover relief should be available so the tax is deferred until such time as the trustees dispose of the asset.

2. Control

The trust is run and controlled by trustees. The settlor can choose who the trustees are and the trustees can include the settlor and/or beneficiaries. The trustees are responsible for looking after the trust assets for the benefit of the beneficiaries. The trustees run the trust under the terms of a trust deed which is often drafted to be as flexible as possible.

The trust deed confirms who the potential beneficiaries are of the capital and income and the trust deed usually offers the flexibility of the allocation of income and capital between the beneficiaries. The trustees then have flexibility as to who should/should not receive income or capital from the trust and the timing of any receipts.

3. Income

To be effective for IHT purposes, the settlor must not reserve a benefit in the assets given away. It is usual to see the trust deed specifically exclude the settlor from benefiting. Therefore the settlor cannot receive any income nor have any use of the asset of the trust (unless market rent is paid for use).

Trusts pay income tax at up to 45%. If income is distributed to beneficiaries then the income is received with this tax deducted at source. Therefore if the beneficiaries pay tax at lower rates they can reclaim the difference.

4. Future IHT

The value of trusts assets do not fall in an individual’s estate on death. Instead, an IHT event arises every ten years and when an asset leaves the trust. The IHT charge on either event will be up to 6%.

Family Investment Companies

1. Creation

The founder of a Family Investment Company can transfer cash or assets into a limited company in return for a loan or shares. As the founder is receiving value in return there are no IHT implications of the transfer. Conversely, if assets are transferred, and they stand at a capital gain, CGT may be payable unless holdover relief is available. In addition, if property is transferred into an FIC, stamp duty land tax may be chargeable on commercial property worth more than £150K.

2. Control

An FIC is owned by shareholders. The founder of an FIC can have shares in it and on creation would transfer shares to other members of the family. There is likely to be some flexibility of control and rights with the use of different share classes so that the founder can retain voting control and other shareholders having similar or varying rights to capital and income.

3. Income

FICs pay corporation tax at 19% and, for FICs owning shares; dividends are exempt from corporation tax. Therefore an FIC allows income retained to grow wealth tax efficiently.

The directors and shareholders of the Family Investment Company have the flexibility to decide whether to distribute any of the income as dividends to the shareholders or to retain the profits in the FIC to reduce debt or invest further.

The founder can receive income, without a tax charge, by repayment of the initial loan. The founder can also receive a salary for services and dividends can be paid to the shareholders. Dividends are chargeable to income tax on the shareholder at a rate of nil% to 38.1%.

4. Future IHT

On the creation of the Family Investment Company, the founder is unlikely to have passed much value to the next generation. The shares are worth a minimal amount because the founder has passed assets or cash into the FIC in return for a loan so the two net it each off. However, over time, the FIC will grow in value, and therefore so will the shares. The articles can be written so the children’s shares receive all growth in value, or growth over a certain level, which is both IHT efficient and can incentivise the next generation to grow the wealth. In addition, the founder can utilise the IHT annual allowance by making gifts of the loan and/or shares, to the next generation.

Unlike trusts, there are no ten yearly IHT charges. Instead, the value of shares retained will be in the shareholders estate for IHT purposes.

FICs are particularly attractive for assets expected to rise in value in the future. For example, FICs are often used for potential solar parks and property developments, where land is transferred at a low value, in consideration of a loan to the founder. The increase in value can then be held by the next generation whilst access to income and control can be retained by the founder.

Both trusts and FIC’s have their place in tax and succession planning. If the ten-year IHT charges can be managed a trust can help mitigate many generations of IHT charges whilst protecting the assets for future generations with appropriate control and supervision. In some cases, the use of trusts and Family Investment Companies are appropriate to balance control and flexibility as well as income tax efficiency across the family and business.