Is now the time to open a tax-efficient Family Investment Company?
If you have been considering how you would like to pass wealth on to the next generation, now may be a particularly good time to establish a FIC, given current depleted asset values.
As many people have seen the value of their assets drop, and indeed face further potential drops, passing wealth on now through a FIC while assets are at a lower value, may help to reduce the tax burden on your loved ones.
What is a Family Investment Company?
A FIC is a company with a specific purpose that can be used to pass wealth down the generations while maintaining control over it.
A classic use of a FIC is where an older generation such as parents want to make a generous gift to a younger generation such as their children (adults or minors) but want to maintain control over the investment strategy of that gift.
It is often very appealing to parents to have the ability to phase a gift to children and control when and how much of that gift the children should receive. Historically, a trust may have been used for this purpose, but changes to the trust tax rules have made trusts less attractive. Now, in most cases, gifts to a trust in excess of £325,000 incur a lifetime inheritance tax (IHT) charge.
A FIC is structured such that all or most of the voting control sits with the parents but the value and future growth in value of its shares accrues to the children. There is no maximum number of people who can be involved in a FIC.
Provided the parents survive seven years from setting up the FIC, most of the value contained within the FIC does not form part of their estate for IHT purposes. For example, on a transfer of £1m, something in the region of £400,000 in IHT can be saved, while also retaining control over the £1m.
There are numerous ways to set up a FIC and it can be complicated. They generally have different ‘constitutions’, for example, a standard trading company and different aspects that need to be considered. It does, therefore, require specialist expert advice when they are established.
Are there other advantages?
The other tax advantage of a FIC is that investment returns are subject to the lower levels of tax that currently apply to companies. The headline rate of tax for income and gains in a company is 19% compared to the highest personal tax rates of 45% (38.1% for dividends) and 28%, respectively.
Perhaps most significantly, most dividend income received by FICs is not taxable at all unless and until it is distributed to shareholders. Consequently, a £10,000 dividend received by a company can be re-invested in its entirety whereas the same dividend received by an individual could be as little as £6,190 after income tax.
The compounding effect and financial benefits of reinvesting gross income (£10,000) rather than net income (£6,190) can be substantial in the longer term. It is for this reason, that companies can and are used as investment vehicles in their own right, irrespective of any objective to pass wealth to the next generation.
Additionally, it is worth mentioning that management and administration fees, such as investment management fees, tax reporting and so on, are generally deductible against income for corporation tax purposes. Such expenses are not, however, relievable for individuals.
What else should I be aware of?
FICs do require a level of compliance, including annual accounts, corporation tax returns and annual confirmation of shareholders. Companies are also required to register certain information at Companies House and this register is open to the public. Whilst it is possible to minimise the amount of information on the public register, this is still something people may wish to take into account.
Additionally, where you want to take funds out of the company, there is some administration that goes along with that. Whilst this is not complicated, it is important for the family to get into good habits early on.
Is now a good time?
Yes, from a tax point of view, there are two good reasons to set up a FIC and these are linked to two specific taxes:
Capital Gains Tax (CGT)
If you want to fund a FIC with non-cash assets, then on a transfer of assets standing at a profit, this can trigger a capital gains tax charge, subject to the availability of the annual exemption.
As uncertainty with the market continues, however, this presents an opportunity to transfer non-cash assets such as stocks and shares which have previously stood at a gain, into a new corporate tax-efficient wrapper such as a FIC, without realising prohibitive capital gains tax charges in the process.
It might also present the opportunity to utilise previously realised capital losses to offset against gains realised on a transfer of other assets standing at a gain to a FIC.
If an individual dies within seven years of making a gift, the value of that gift is in their estate for IHT purposes. The value that is brought into account is the value at the date of gift, not at the date of death. Consequently, gifts during a time of lower values give less exposure to IHT.
Any growth in value from the date of gift is also removed from the donor’s estate, provided they cannot personally benefit from it.
Julia Rosenbloom is Partner at financial and professional services group, Smith & Williamson