Family Investment Companies

Structure

An example FIC structure could be as follows:

• The parents fund the FIC either with loans (interest-free or interest-bearing) or by subscribing for preference shares. This is not subject to Inheritance Tax (IHT) and funds can be extracted at a later date tax-free.
• The parents subscribe for voting shares in the FIC, which give control of the company.
• The parents also subscribe for non-voting shares (could be multiple classes). The parents give non-voting shares to their children (before the shares have significant value so the gift is not subject to IHT). The non-voting shares may pay dividends in future.
• The parents could also set up a discretionary trust for the benefit of their minor children without triggering an IHT charge. The parents should be irrevocably excluded from benefiting from this trust. The trustees then subscribe for a class of non-voting shares in the FIC at nominal value as the company is being newly created.
• The company could be an unlimited company rather than a limited company, to reduce the filing requirements. However, a ‘small’ limited company only needs to file abridged accounts with no profit and loss account or directors’ report and there is no audit requirement.

An unlimited company will not have the same protection from creditors as a limited company although, assuming that the only assets held by the company are, say, investments (and not property for example), it is unlikely that claims will be brought against the company.

It is advisable to appoint at least two directors to manage the FIC to ensure continuity of the company’s affairs.

Corporation tax

The company will pay corporation tax at the main rate of 19%, increasing to 25% from 1 April 2023 for annual profits exceeding £250,000. A ‘small profits rate’ at 19% will be introduced for companies with annual profits below £50,000. Where a company’s profits fall between the upper and lower limits, marginal relief provisions will apply.

However, the small profits rate will not apply to ‘close investment holding companies’ which include family investment companies primarily holding stocks and shares, but do not include property investment companies.

Capital gains

Capital gains realised by the company are chargeable to corporation tax at 19%. At present, this is lower than the current main rate of capital gains tax (CGT) of 20% (28% on residential property) that would be payable by an individual.

Dividends

Most dividends received by a UK company (including foreign dividends) are exempt from corporation tax.

Tax relief on interest (e.g. to leverage a share or property portfolio)

The company will be able to claim corporation tax relief for interest on loans, where the loans are used for the purposes of the company’s business (eg acquiring new shares or property or generally managing its business). 

Individuals, however, do not receive claim tax relief on interest on loans to acquire shares, but they receive a 20% tax credit on loans to purchase property.

Management expenses

Corporation Tax relief applies to investment management and general business expenses, including fees and remuneration paid to employees and or directors. Certain expenses are not usually eligible for tax relief, for example, entertaining.

Companies have an advantage over individual investors because they do not receive tax relief on the investment management expenses.

Potential dry tax charges

Under UK GAAP FRS102 (1A) standards, mark-to-market principles apply on certain items. The company is taxed annually on the increase in value on a ‘fair value’ basis (rather than on disposal) on certain holdings:

• Some investments are subject to mark-to-market accounting. If the value of the investment increases, this can lead to ‘dry tax charges’, i.e. tax on unrealised gains. These investments include bonds, government gilts and other debt securities. 
• The same issue can apply to debtor and creditor balances, and if they are in foreign currency, any foreign currency gain may be taxable. Care is needed when an FIC is funded by a significant non-sterling shareholder loan.

Shareholder taxation

Shareholders will be taxed on income extracted from the company:

• Income tax on dividends – the highest rate is currently 38.1%, and increases are scheduled. For basic rate taxpayers, e.g. children 18 and over, the amount in excess of the combined personal allowance and dividend allowance (£14,500 for 2020-21, and £14,570 for 2021-22) will be taxed at 7.5% at the basic rate and 32.5% at the higher rate.
• Income tax on salaries (if the shareholder is also an employee) – up to 47% (including employee’s National Insurance contributions). Different rates apply in Scotland; or
• CGT on capital on the liquidation of the company – at 20%, provided no similar trade for the next two years.

HMRC review of FICs

In April 2019, HMRC set up a specialist unit to review the use of FICs as an inheritance tax planning vehicle. In May 2021 they confirmed they are content that FICs are primarily used to transfer wealth between generations and not as tax avoidance vehicles.

While there is scope to benefit from lower corporation tax rates in the short term on property disposals, there are solid commercial reasons for having an FIC. The use of these structures does not suggest those taxpayers that use them are non-compliant when it comes to their tax affairs. FICs are now being brought into ‘business as usual’ within HMRC. Such entities will not require to be dealt with by a dedicated team at HMRC.

The minutes of the unit are available here: https://www.gov.uk/government/groups/high-net-worth-unit-external-stakeholder-forum – see section 5.

There has now been a budget (Autumn 2021) and the following Finance Act since the unit’s report, where the Government did not make any significant changes to the taxation of FICs, or introduce any new anti-avoidance rules. 

Press coverage

ft.com HMRC closes unit set up to investigate family investment companies

Investors Chronicle

City A.M.

FIC Presentation

One of our partners recently gave a talk on FICS  – see here.

This information is based on law and HMRC practice on 13 December 2021.