Why you should use a Family Investment Company to avoid Inheritance Tax on Large Estates
This article explains all the benefits that accompany using Family Investment Companies (FICs). An FIC may be a beneficial solution to your Inheritance Tax problem if your estate exceeds £2million in value.
What is an FIC?
An FIC is a company with bespoke Articles of Association and multiple share classes. They are usually limited, but can be unlimited if it is only investments that are held in the company and not property. FICs are set up by tax specialist tax consultants together with lawyers. They are most often used by people who have large property portfolios.
How Does the Process Work?
Usually, a registered partnership is set up between spouses (rather than you filing your tax returns individually). After three years, the partnership is incorporated, and properties are placed into the company using Incorporation Relief to avoid Capital Gains Tax (CGT). This method is also useful for clients withlarge investment portfolios with potential large CGT issues. Here, shares are gifted as fast as possible into the company to avoid CGT.
How is an FIC Set up?
The people gifting the money into the company will generally have A-class shares. When they gift the money into the company, it is offset on the balance sheet as a Director’s loan. The people setting it up become Directors and retain control. The Director's loan is then repaid over the years income tax free as it is classed as a return of capital. It is the normal income from property portfolio thatrepays the Director’s loan. Corporation Tax is payable on profit, but at 19% it is lower than Income Tax.
Usually, when you reach the age of around 75-78, a Director’s loan is given up asa Potentially Exempt Transfer (PET) and therefore avoids Inheritance Tax if it survives the seven-year period. Corporation Tax is payable – but only at 19%. As it is a company, Section 24 on Buy To Let properties does not apply, and as a result, all interest is offset against profits (not just the 20%). You can also get paid an income as Directors.
You would only own the A shares. Usually, your children would have the B and C shares which would also grow in value in line with the company's property or share portfolio. This stops the Inheritance Tax from getting worse.
Despite having shares, your children would not be Directors so you continue to control the company until old age. Here, there is an added benefit that only direct descendants can own shares which provides protection (for example, if one of your children was to get divorced).
FICs are particularly beneficial for people whose estates exceed £2million (or people with assets that exceed £1 million excluding their main residence). They are a good way of potentially eliminating Inheritance Tax on large estates. However, there is the risk of future attacks by changes to legislation HMRC,meaning that you should not solely rely on this mechanism. FICs should always be set up alongside Trusts as retrospective changes to Trust legislation is very unlikely.
What are the Main Benefits of FICs?
- You can avoid CGT normally payable on passing a property portfolio into a company if done correctly.
- It can generate very low levels of Income Tax.
- It avoids Inheritance Tax on very large assets.
- It retains complete control on assets and income streams.
What are the Negatives of This Strategy?
- FICs do have the potential to be attacked in the future by HMRC. This is the main negative of using FICs.
- If your income is based upon property income, then this can be inflexible.
- You will have Accountancy fees that you need to manage annually.
It is very wise to not rely only on FICs. You should always consider the use of maximum investment into Trusts as well. Alternatively, you could invest some money into Business Relief plans.
You should always place the maximum amount possible into Trusts because this provides huge backup assets should you need them (for example if you went intocare). Also, this may be necessary if you find yourself giving away your property portfolio given that your main income from an FIC stops at age 78.
However, this can sometimes be a difficult concept for property landlords who feel comfortable having all their money in property. Your return may be lower, but it will have a higher level of certainty as you avoid IHT and you have capital/income back up.
FICs are good for people with large estates as there are few other options. It alsooffers protection as large gifts to children could be lost in scenarios such as divorce. However, to give yourself the highest level of protection, you should always use maximum investments into Trust. Together, this means that you get certainty on IHT avoidance.
Like all matters related to Estate Planning and Inheritance Tax, experienced advice is essential.
Call us if you require any help.