Why is it wrong to recommend Limited Companies?
Most high street Accountants are not tax planners. This means they are not specialists who fully understand Family Investment Companies. All landlords with a property portfolio worth more than£1 million will carry a significant inheritance tax problem. Most landlords will want to pass their properties onto their families without leaving a large inheritance tax bill and a simple limited company is not suitable for achieving this aim.
How can this be achieved?
One possible way this can be achieved is through gifting property to your children. If you live for seven more years, this would be a Potentially Exempt Transfer. However, the issue here is that it generates immediate Capital Gains Tax, which is a different problem. Also, gifting the property to your children means that you can’t retain an income from the property portfolio. For these reasons, gifting the property may not be the best way to pass on properties as a means to avoid paying inheritance tax.
Another point to consider is that the children may be close to or higher rate taxpayers, meaning the rental income will be subject to higher rate tax.
Setting Up a Family Investment Company
To understand more about Family Investment Companies (FIC), please refer to an earlier blog that explains this in more detail.
Why you should use an FIC to avoid inheritance tax
When you set up an FIC, it will cost around£5,000 or more. By contrast, it costs £400 to set up a standard Limited Company. However, once the tax rules of an FIC are established, the same tax rules apply as a regular Limited Company.
So how do you get around the issues relating to Capital Gains Tax? You can do this by first setting up a registered partnership. Whilst you may still have to pay an accountant to do a tax return, you will have a tax-saving as you can vary the income between partners without changing the ownership of the properties. There is no Capital Gain Tax (CGT) or Stamp Duty Land Tax (SDLT) on the set-up of the partnership.
Once you have the properties in the partnership, you will have to hold the partnership for approximately three years. After this, you can convert the partnership into a Family Investment Company. Essentially, you are converting one type of business into another. When you have converted, you can claim incorporation relief, and at that point, there is no CGT or SDLT on the set-up. The CGT is not lost – it is simply deferred – possibly indefinitly.
A normal “off the shelf” Limited Company has standard Articles of Association. These are the rules of the company. When you convert to an FIC, you are changing the Articles of Association. Here, tax accountants will use specialist Lawyers to write different Articles on a bespoke basis for the FIC. How complex you choose to make the rules will therefore impact the set-up costs.
The long-term income tax and inheritance tax savings will make the set-up costs negligible compared to a regular Limited company.
What happens when you set up an FIC?
The share value of the capital shares is the original purchase price of the properties. The day after set up, the share value is based on the net current value of the properties. This means that you have swapped CGT for Corporation Tax rates (where the rates are lower). The Capital shares are for parents in exchange for Properties. This means that there is no exchange of value and, therefore, no CGT. You can also set up a Directors Loan Account in exchange for the current value of some the properties but this will generate a CGT issue. Another thing that you should do when setting up a company is include “entrenched directorships.” This gives you income for life for being the Director of the Company when the shares are eventually given away.
The other thing that you should do is set up 'Alphabet Shares.' Here, the children and adult grandchildren get non-voting growth shares. They do not get capital shares. This stops the inheritance tax problem from getting worse as all future growth belongs to your children.
This means dividend distribution of profits can be controlled dependent of other income. You are only allowed to own shares if you are a family member. This means that the value of the children’s share are reduced in a divorce case.
Another significant benefit of an FIC or any limited company is that you can make pension contributions for your adult children and grandchildren who will become employees. This is deductible before tax from profits. Once the Director’s Loan is fully repaid, parents can still get income as Directors. Over the years, capital shares should be gifted away using the CGT allowances.
Employee Benefit Trusts
If the CGT is large, an Employee Benefit Trust (EBT) can be used. This is because gifts to an EBT are immediately inheritance tax-free. This is how you defer the CGT for many years.
This is complex planning, so specialist tax accountants and Lawyers are required. You should not rely on your existing high street accountant. Bluebond has strong relationships with a number of firms that set up FICs. To save you money, we explain it to you and then refer you to a firm that will suit your needs. There is no limit to the size of a property portfolio for an FIC. You could go up to £100 million if you want.
What are the Main Benefits of an FIC?
1. Entrenched Directorship is possible. This means that it doesn't matter who owns the shares; if you set up the company, you are a Director for life. This is not the case in a regular Limited Company.
2. You can set up Alphabet Shares to control dividends and reduce income tax.
3. You retain control of your company in the family bloodline.
4. You avoid inheritance tax without paying CGT.
A word of caution
Despite all of these benefits, you should not only rely on a Family Investment Company to fully deal with your inheritance tax problem. This is because Section 24 illustrates that HMRC will make specific tax rules for Landlords. They could easily do this for companies that mainly own rental properties.
Landlords with large existing CGT build up in their rental portfolios have little choice in setting up an FIC as Trusts are limited to £325,000 per person every 7 years.
You should also be putting investments into Trusts. If you gift all of your shares away, you can only get a limited amount as a Director. You will also need the safety of capital behind you when you are elderly if anything goes wrong medically. For example, you may need to go into care. You should use a balance of FICs and Trusts as retaining capital shares in your company will be subject to inheritance tax.
You need experienced advice and an integrated plan using a mixture of different plans tailor-made to suit you and your family.
Like all matters related to Estate Planning and inheritance tax, experienced advice is essential.
Contact us if you require any help.