Family Investment Companies
If you have assets over £2 million, excluding the value of your main residence, we may advise that you look into setting up a Family Investment Company (FIC) Doing this would allow you to pass on your wealth to your children by way of shares in that company.
Setting up a family investment company will allow you to place cash or assets into that company, and pass on your wealth potentially free of Inheritance tax but retain control over the asset during your lifetime. Companies also offer a more effective tax environment for growth assets than holding them personally especially rented property.
As you will be named as a director and be a preferential shareholder, you will have all voting rights and therefore control over the capital held in the FIC. It is important to understand that this will not give you rights to the capital itself.
After seven years, the value of the money or property transferred into the FIC will fall outside of your estate for inheritance tax purposes so long as you keep no beneficial interest in the company.
A shareholders agreement will need to be drawn up as a private contractual document between the shareholders. The shareholders of the company will only be family members and also a family trust if applicable.
In order to make the FIC suitable to operate in a family estate planning context, it is effectively treated as a private limited company with bespoke articles of association. It is important to bear in mind, however, that companies are often subject to many tax changes and reviews meaning that there is a certain element of risk that a negative change may occur in the future.
The articles set out the different rights and interests for each of the shareholdings in the company. By setting these share classes, often referred to as ‘alphabet shares’, each family member can be allocated a different class of share. These classes will be determined by the role of each family member and their rights to the value of the assets within the FIC. This means the family members can have varying levels of control over company decisions, rights to receive dividends and entitlements to the capital value of the company.
If the assets currently belong to the parents, and they can use the company structure to transfer value and responsibility to their children dependent on Capital gains tax issues and their own income needs. This provides the parents with an effective method of controlling family wealth through their lifetime.
An added benefit of protecting your wealth in this way is that the articles can be set up to include specific clauses that protect the shares in specified circumstances. These can prevent shares being transferred outside of the family by restricting shareholders to immediate family or family trusts. As an example, the article could state that should a child divorce their spouse, that ex-spouse will not be able to retain shares in the FIC, meaning that the assets should not be included within any divorce settlement. Please bear in mind. However, that should the case be brought in front of family courts, a judge may have the power to pass other assets disproportionately to ensure a “fair” divorce.
As previously explained, the value of these shares will fall outside of the parent’s estate for Inheritance Tax purposes seven years after the share has been “gifted” from the parents to the family member. There are some tax considerations to be aware of in transferring the value and rights of chares from parents to other family members so the transfers can be carefully planned to control the timing and value that is transferred and the tax implications for the family shareholders.
With this in mind, loans of cash or assets from the parents is a common way of funding FICs initially (and therefore establishing the value the company has available to invest).
The parents often hold preference shares based on repayment of loans to the company and can withdraw funds tax-free. This is because repayment of capital at base value is not subject to income tax or capital gains tax.
One of the main advantages of a FIC over a lifetime discretionary trust is the tax regime applicable and applies when the value is over £1 million. Whilst FICs are subject to corporation tax on the income they receive, this income can be charged at a lower rate than the personal marginal income tax rates. Also, mortgage interest is fully reclaimable and not subject to a 20% tax credit as would apply to normal Buy to let property holdings.
Should the FIC hold an investment portfolio of UK companies, most dividends received by a UK company from other companies is currently exempt from corporation tax. This beneficial nil dividend rate for companies results in an increase in the growth roll-up of dividend income by deferring taxation until monies are distributed by the FIC.
There are other practical advantages, depending on the family’s approach to investments. For example, the FIC’s directors can choose to take greater risks from an investment strategy perspective than trustees might be comfortable with as trustees have to abide by trust law.
In my opinion, the best strategy for a wealthy family with investable assets exceeding £2 million can often involve combining the structures of an FIC and a discretionary or reversionary trust.
Like all IHT planning, the devil is in the detail and so experienced professional advice at the outset and throughout your lifetime is essential.