Individuals often seek efficient structures to pass wealth on to children, whilst retaining the desired control of their assets/investments as they may have concerns over the ability of their children to appropriately manage significant investments. Complexities surrounding the taxation and legal position of trusts have left many looking for alternatives.

Family Investment Companies (‘FICs’) are investment vehicles which are becoming more widely used as an alternative to trusts for investment and succession planning purposes.

FICs enable individuals to transfer wealth to relatives. Transfers of value to individuals are potentially exempt from inheritance tax, such that no inheritance tax will arise if the donor survives seven years from the date of the gift. However, capital gains tax may arise if assets standing at a gain are transferred to other family members.

Shares in a FIC can be given to relatives and, depending on the rights of the shares, relatives may be able to receive distributions from the company.

FICs may be suitable where funds will be invested for the longer term as the corporation tax payable by the company will generally be lower than personal income and capital gains tax liabilities. Personal tax liabilities may arise on extraction of funds from the company.

This article briefly outlines the main tax aspects of FICs. The investment, legal and regulatory aspects of establishing a FIC should also be considered and appropriate advice should be taken on each of these aspects, including tax, before establishing a FIC.

Formation

A FIC is a UK resident company which pays UK corporation tax in the usual way. Each company however is bespoke and designed to take into account the particular circumstances of the family.

Funding

A FIC is normally funded in one of two ways; by way of subscribing for shares or by way of loan. If the FIC is funded using cash to either subscribe for shares or to make a loan, there will generally be no immediate tax implications, provided the funds transferred to the FIC and the value of interests received in exchange are the same.

A capital gain or loss may arise if assets, other than sterling cash, which are already held and which are standing at a gain or loss are transferred to the FIC. Capital gains tax will be payable if gains are realised on the transfer of assets to the FIC. A capital loss will arise if assets standing at a loss are transferred to the FIC, but it may only be possible for the loss to be relieved against gains realised on transfer of other assets to the FIC, as the FIC will be deemed to be connected.

Structure of share classes

Separate classes of shares may be created to be held by different family members, and the family members’ interests in the FIC may include:

• Ordinary shares: It is possible to have more than one class of ordinary share to be held by different members of the family, which may, for example, have different rights to receive dividends and different rights to vote on matters affecting the company.
• Interest bearing loans or preference shares which carry an entitlement to dividend income could be issued, which may provide a fixed income stream.

At a later date, shares with voting rights could be given to, or subscribed for, by younger family members, to increase their involvement in running the FIC.

However anti-avoidance legislation, such as value shifting provisions, may need to be considered if new share classes are introduced or rights altered at a later date. These provisions can give rise to capital gains tax charges in certain circumstances.

Succession

Shares in the FIC may be gifted to family members without an immediate charge to inheritance tax arising, as gifts to other individuals are Potentially Exempt Transfers (‘PETs’).

Capital gains tax is likely to arise if the value of shares at the date of gift is more than the original cost of the shares to the donor.

No inheritance tax is payable on gifts of shares to individuals, provided the donor survives for seven years after making the gift, otherwise up to 40% inheritance tax is payable on the value given away. The rate of inheritance tax payable gradually reduces once the donor has survived three years from the date of the gift. The inheritance tax positions of the founder and other shareholders need to be considered carefully, as up to 40% inheritance tax could be payable on the value of each individual’s interest in the FIC held on their deaths (e.g. the value of shares).

Other anti-avoidance provisions may need to be considered and detailed advice is necessary.

Taxation while profits are retained in the company

Corporation tax

UK resident FICs are required to pay corporation tax on profits. As FICs tend to make investments, rather than trade, and often have a small number of shareholders, they are generally classified as close investment holding companies and are required to pay corporation tax on profits at the main corporation tax rate, currently 21%, though corporation tax is not normally payable on dividend income. From 1 April 2015, a single 20% corporation tax rate will apply to all companies.

By comparison, individuals are required to pay up to 45% income tax on income, except for dividends which are generally subject to an effective tax rate of up to 30.56%.

Corporation tax will be payable on any capital gains realised by the FIC at the corporate tax rates set out above. Unlike individuals, companies are able to claim indexation (an allowance for inflation) on disposal of assets. Individuals are required to pay up to 28% capital gains tax on gains realised.

Extraction of profits

Some of the possible methods of profit extraction from a FIC, and brief comments on the tax treatment are as follows:

Dividends

Individuals are generally required to pay income tax on the extraction of profits from companies at an effective tax rate of up to 30.56%. There could be an element of double taxation where dividends are received by individuals, as profits are already subject to corporate tax when made by the FIC.

Repayment of loans

If the founder lends funds to the FIC, the loan could be repaid tax free. Income tax would be payable on any interest the individual received on the loan. The company would normally be able to deduct the interest payments from profits before applying corporation tax.

Sale or liquidation

Capital gains tax may arise if shares in the FIC are disposed of at a gain, for example, on sale, at a rate of up to 28%. A capital gain may also arise if the company is liquidated. However, it should be noted that anti-avoidance legislation may apply if the FIC has funds which could be used to pay a dividend.

Remuneration and benefits

If individuals receive remuneration (including benefits) from the company due to being an employee or director, they will be required to pay income tax at their prevailing tax rate. National insurance contributions (NIC) will also be payable by both the FIC and the employee/director. Both income tax and NIC would be collected through PAYE. Due to the payment of NIC the total amount payable to the Exchequer may be higher than if the underlying income were received personally. The company should however be able to deduct remuneration paid to employees and directors from profits before applying corporation tax.

Where appropriate, the FIC could contribute to a pension for the benefit of employees or directors of the company, though this is a complex area and specialist pensions advice should be sought.

Other practical considerations

Understandably the tax effects of investment structures are only one of the considerations for individuals. Appropriate tax, legal, regulatory and investment advice should be taken before establishing a FIC.

The following are some additional points to note:

• Day to day control of a FIC rests with the board of directors. The directors can decide how the funds are invested and vote on the extent to which dividends should be paid to different classes of shareholder. The founder could choose who to appoint as director(s) of the FIC when it is established, which could include himself/herself if there is a wish to retain control of the funds, or other family members. In essence, it is up to the founder on set up to dictate how tightly controlled the FIC will be.
• Typically FICs are established as unlimited companies. Limited companies are generally required to file accounts with Companies House on an annual basis, which are publicly available. Unlimited companies do not have this requirement. However unlimited companies expose the shareholders to any potential debts which the company fails to discharge, a significant factor which should be considered. Note however that the UK government are introducing a register of people with significant control over/beneficial ownership of certain UK legal entities, including UK incorporated unlimited companies. If enacted as planned, the benefit of privacy associated with unlimited companies will be reduced.
• There are no particular restrictions on the types of assets a FIC can hold, though careful consideration should be undertaken where the assets may be eligible for tax relief if they were acquired directly by the individual. For instance, if shares to be acquired may qualify for relief under the Enterprise Investment Scheme or would qualify for Business Property Relief from inheritance tax if held personally.

Peter Davis is a Tax Assistant Manager with Deloitte in Belfast.

Tel/Direct: +44 (0)28 9053 1310

Email: pedavis@deloitte.co.uk