Inheritance Tax / Financial planning / Estate Planning

Can I use a Family Investment Company instead of a trust?

Before 2006, trusts were a popular way of setting aside wealth for younger generations, allowing families to transfer assets and money without necessarily the threat of Inheritance Tax or losing control. Claire Spinks, our Head of Tax Technical and Development, explores an option which offers a possible alternative to trusts – a Family Investment Company.

What is a Family Investment Company?

Simply put a Family Investment Company (FIC) is a company like any other. It’s defining characteristics are that its shareholders and directors are family members, and that its purpose is to invest, not trade, and provide capital and the option of income to a particular family. Typically, a FIC can invest its capital, although it is possible to hold any asset, including property, in this structure.

Can FICs replace trusts?

Whilst a useful tool, FICs can’t truly replace trusts. Whilst trusts might be costly from a tax perspective, they are the best option where the main aim is to maintain a high level of control. The deed of a trust allows the settlor, on creation, to set out how the funds are used and dictate who benefits, even for future generations.

With a FIC the ability to control rests with carefully drafted articles of association, which set out the shareholders rights, and a shareholder’s agreement. Unlike a trust a FIC can only be used to benefit living and named individuals: the shareholders. However, many families considering this option often use a trust in addition to a FIC, allowing the trust to hold shares for future generations or groups of beneficiaries.

What are the Inheritance Tax consequences?

FICs can be far more efficient than trusts, depending on the value being gifted. Setting up a FIC often involves immediately gifting shares or funds to allow each family member to subscribe. In both cases, those gifts would be a ‘potentially exempt transfer’ for Inheritance Tax (IHT) purposes and would only attract IHT if the gift or survived less than seven years. If this happens, the giftee may find themselves suffering IHT on that failed potentially exempt transfer.  Unlike Trusts, a FIC does not suffer IHT; instead, the value of each individual’s respective shareholding would be treated as an asset of their own estate.

On the other hand, transferring funds into a trust would create an immediate lifetime IHT tax bill of 20%, for anything which sits over of the individual’s available allowance (currently £325,000). If the giftor didn’t survive seven years, further tax bills of 20% would be payable. In addition, trusts also attract IHT at 10 yearly intervals and when funds are withdrawn, albeit at lower rates.

What about Income Tax and Capital Gains Tax?

FICs also offer other tax benefits. Whilst trusts might pay the highest rates of tax (similar to an additional rate taxpayer) company corporation taxes are much lower, currently sitting at 19%. If the FIC holds property, there’s also a benefit in that no loan relief restrictions are applied.

But shareholders need to consider dividend tax which is due on any income over the current allowance of £2,000, when receiving a distribution from a FIC: a higher rate taxpayer would have to pay 33.75% in addition to the 19% already paid at company level. That equals a hefty 52.75% overall tax bill – far more than the 45% that would be experienced by trustees. Basic rate taxpayers don’t fair so badly with a 27.75% overall bill.

What’s the catch?

With correct planning and advice, there shouldn’t be issues. The downfall of any FIC is where it’s used to achieve too much – saving IHT, retaining tight control and reducing other taxes.

FICs are good for saving IHT, especially in situations where an outright monetary gift might seem slightly inappropriate. Perhaps the funds sitting within a company set up, shared by family members and governed by a board of directors (grandparents/parents) is stability enough. However, if it isn’t and it’s felt that certain individuals may need voting rights removed or specific clauses included, trusts should be re-considered.

And if income is the primary goal, FICs may not be the best route. Whilst lower corporation tax rates might seem attractive, any income could be depleted by overall higher tax rates, especially when dividends are being declared to those that don’t need them.

Whilst income shares, alphabet shares and dividend waivers have been used in FICs to push income to certain shareholders above others, HMRC are wary of these ‘arrangements’. Attempting to make the FIC hugely benefit the family from an Income Tax perspective, may mean it ultimately doesn’t achieve its initial objective – to pass on wealth efficiently by saving IHT.

Should I use a FIC?

If you are looking to pass on some wealth, a FIC might be a good route, but it should always be considered alongside other options. Some people like the idea of a FIC for additional reasons – it can pull together a family unit and engage younger generations in planning and finance.

To discuss any aspect of tax or estate planning please contact your nearest office.