FIC – Protecting the family future

Consider the role that family investment companies can play in passing down generational wealth in a tax efficient manner.

HMRC’s Satisfaction with FIC

In today’s world, family investment firms are becoming increasingly popular. HMRC’s specialist unit formed to investigate family investment companies was disbanded in August after finding no evidence to support the claim that the vehicle was being abused to avoid tax. HMRC discovered no link between individuals who established family investment companies and tax evasion.

This does not preclude HMRC from reopening an investigation into this vehicle in the future. However, the investigations’ findings are reassuring, demonstrating that the family investment company is a useful and legitimate tool for passing down generational wealth in a tax-efficient manner.

What is a family investment company?

A family investment company is essentially a private company whose shareholders are various generations of a family, and which was formed with the primary goal of preserving family wealth. It enables the parents (or founding members) to keep control of the assets while growing their wealth in a tax-efficient manner. It is also viewed as an alternative to a trust, allowing family members to hold various economic interests in the family wealth in the form of shares rather than disturbing fractional interests within assets to the next generation.

A family investment company will follow the same regulations as are required for the management of a private company. It must be registered at Companies House and will appoint directors, provide articles of association, a memorandum of association and shareholders agreement, file annual accounts and disclose details of persons with significant control. It must send a company tax return to HMRC and pay corporation tax.

When establishing a family investment company, it is critical to consider a variety of factors. The primary question is, of course, who will be the future recipients, but there are a number of other issues to consider, such as grandchildren, divorce, and death. When drafting the customised articles of association and the shareholders agreement, these elements should be taken into account. These agreements are essential for establishing a family investment firm since they reflect the shareholders’ rights and controls and can be tailored to the family’s needs. They will feature a share structure that will allow the economic interest to be passed down to the children individually according to their needs, while the parents or founding members retain control (in the form of directorship) over the assets, investments, and dividends.

Provisions can be made to limit the transfer of shares or to prevent the amendment of the various share classes’ rights to income and/or capital. They can also include exclusions for circumstances that would result in a mandatory share transfer, such as divorce or death. Drag-on clauses (which allow a majority shareholder to force a minority shareholder to participate in a firm sale) and stalemate provisions can be included in the articles of association to protect family wealth even more.

When would you use a family investment company?

When seeking advise on future success planning, a family investment organisation should undoubtedly be explored. Many people are familiar with the use of trusts to pass down wealth from generation to generation; however, a family investment firm can also be a great way to do so.

Individuals with a corporate or entrepreneurial background are likely to find this strategy appealing. For example, many business owners may feel more at ease working with a family investment company since they already have a lot of experience dealing with companies from a legal and administrative standpoint.

Parents would put money or assets into the family investment firm and then give their children non-voting shares, thereby making them shareholders in the company. The shares are usually alphabet shares, which allow the corporation to issue several classes of shares to different stakeholders. This permits family investment organisations to pay dividends to shareholders who own a single class of stock without having to pay the same pay out to all of them.

It is very important to get the alphabet shares right in the first instance, taking all considerations of possible scenarios onto account. By gifting the non-voting shares, the economic interest would be passed down to the children while the parents retain control ( in the form of voting shares and directorship) of the assets, investments policy and dividends. This would provide complete flexibility with regards to distributing surplus profits within the family investment company among the family.

Non-voting shares may be setup to carry right to the capital and income in a family investment company. The alphabet shares can also be engineered in a way that they pass responsibility to children in stages as the children grow older.

How is it taxed?

Normally, most donations are subject to inheritance tax; however, assets placed in a discretionary trust are subject to a 20 percent immediate inheritance tax charge (above the £325,000 nil rate band). This is not the case, however, with a family investing firm. There are no upfront inheritance tax charges or immediate tax repercussions when money is invested in a family investment company. For inheritance tax reasons, transferring the shares would be classified as a potentially exempt transfer, taxable only if the donor died within seven years. It would also be a capital gains disposition for the parents, but there should be no benefit in practise if the shares are given up before any increase in investment value.

Disposals within the family investment company such as property or share, could carry corporation tax on chargeable gains and acquisitions could have stamp taxes implications.

The family investment company would benefit from a lower tax rate because it is a limited company, with a corporation tax rate of 19 percent. From April 1, 2023, this rate will increase from 25%. Although dividends are generally excluded from company tax, this would apply to all income and capital gains.

When employing a family investment firm, on the other hand, there may be a ‘double charge ‘ This essentially means that the family investment firm would pay corporation tax on its revenue, earnings, and gains, but shareholders would also pay income tax at the applicable dividend rate when receiving distributions. Because the economic interest is normally held by the children or grandchildren, any income received from the family investment firm would be taxed under self-assessment.

The founder may at some point wish to extract funds from the family investment company. As long as the funds had been injected into the family investment company by the way of a loan, the extraction will be tax free (as it would be treated as a repayment of a loan).

While a family investment firm is seen as a success planning instrument, it is not entitled for any specific inheritance tax reliefs and does not qualify for business property relief ( as a investment company, rather than a trading company). At the time of forming the family investment firm, the inheritance planning would take the form of handing away all appreciation to the capital inside the family wealth. The voting shares held by the parents in our scenario, on the other hand, have value and would be included in the donor’s taxable estate.

Anti-avoidance

A family investment company is by no means a tax avoidance vehicle. There are anti avoidance rules in place which must be considered when setting up a family investment company to avoid falling into any tax traps. These include the ‘settlements’ anti avoidance rules ( Income Tax Trading and Other Income) Act s 624(1); gift with reservation’ Finance Act 1986 s102 (2); inheritance tax anti avoidance provision and the general anti abuse rule(GAAR) and disclosure of tax avoidance schemes (DOTAS)provisions.