Family Investment Companies – a tax efficient and timely opportunity

A Family Investment Company (“FIC”) is a useful vehicle for both passing wealth to the next generation and as an investment vehicle in its own right. It also has potential inheritance tax (“IHT”), income tax and capital gains tax benefits.

What is a Family Investment Company and why might I want one?

A FIC is a company 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, wants to make a generous gift to a younger generation, such as their adult or minor children, but wants to maintain control over the investment strategy of that gift. It is very appealing to parents to have, in particular, the ability to phase a gift to children and ensuring the children do not have immediate access to the value of the gift. Historically, a trust may have been used for this purpose, but changes to the trust tax rules made trusts less attractive. In most cases, gifts to a trust together over £325,000 incur a lifetime 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. 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. On a transfer of £1 million, something in the region of £400,000 in IHT can be saved, while also retaining control over the £1 million.  Whilst the IHT could be saved by making a direct gift to the children, parents may not want them to have this unfettered access for a number of reasons.

Are there other advantages?

The 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% (25% from April 2023) compared to the highest personal tax rates of 45% (38.1% for dividends, increasing to 39.35% from April 2022) and 28%, respectively. Perhaps most significantly, most dividend income received by companies 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 (£6,065 from April 2022).

The compounding effect and financial benefits of reinvesting gross income (£10,000) rather than net income (just over £6,000) can be substantial in the longer term. It may also mean that there is a greater amount of income to pay out to the children ultimately, especially when coupled with reinvestment of at least some of the FIC’s dividend income.

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.

Is now a good time?

From a tax point of view, there are two good reasons:

• Capital Gains Tax (CGT)

  If you want to fund a FIC with non-cash assets, a transfer of assets standing at a profit, can trigger a CGT charge, subject to the availability of the annual exemption.

  The current rates of CGT for higher rate taxpayers are 28% for residential property and 20% for most other assets.  It is, however, possible that personal rates of CGT could increase in the future, potentially being aligned to income tax rates.

  This presents an opportunity to transfer non-cash assets such as stocks and shares which are standing at a gain, into a new corporate tax-efficient wrapper such as a FIC, without realising prohibitive CGT charges in the process.
  
  

• Income tax-dividends

  From 6 April 2022, the rate of tax on dividends for individuals will increase by 1.25 percentage points.  This means individuals will pay income tax on dividends in excess of £2,000 at a rate of 8.75%, 33.75% or 39.35%, depending on whether they are basic rate, higher rate or additional rate taxpayers.  These increases do not apply to dividends received by companies, which remain tax-free in most cases.

  Whilst income tax may apply when individuals take value out of the FIC (though this depends on how the FIC has been structured), this will make FICs even more attractive where the dividend income is being reinvested.

Summary

A FIC is a company with a specific purpose to help your family wealth planning that that delivers you control over assets without creating tax headaches.

Please contact me or your regular Smith & Williamson contact if you wish to discuss further.

Taxation can change – please seek advice before taking any action.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

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