- Pass on assets while retaining control of them
- No IHT if you survive seven years
Earlier in October, we wrote about how trusts can be a useful estate planning tool (IC, 2 October 2020). But if you want to put more into them than your inheritance tax (IHT) allowance of £325,000 you have to pay 20 per cent tax on what is paid in.
Family investment companies offer a different structure via which people can pass on wealth while maintaining control of assets, and can be more tax efficient. If you set one up you can make yourself the director, and control what assets the company invests in and when dividends are paid. The company can also have non-voting share classes, for example for children who could own the majority of the shares. And if you live for seven years after setting up the company the assets you put into it will not be subject to IHT.
Family investment companies are private limited companies whose shareholders are family members. The structure enables parents to keep control over the assets, while growing wealth and facilitating tax-efficient succession planning. There are considerable nuances in how such a company can be set up, which makes them fairly flexible but also quite complicated.
One of the main distinctions between different types of family investment companies is how they are funded. The simplest way to do this is to place cash into the company in return for shares. You can also give the money to your children and ask them to subscribe for shares, so they receive them as a gift. Another option is to lend money to the company. This means you are sharing the growth of the company with shareholders, but retaining the nominal amount that you put in.
You can lay out the terms for the company when you draw up the shareholders' agreement. This means that parents can have controlling rights over the company, and choose when dividends are paid and to whom, and where the company's money is invested.
Who are they suitable for?
Family investment companies are most often used by people with relatively large sums of money as a form of succession planning. They have become increasingly popular since regulations in 2006 made trusts less attractive, and corporation tax has gradually come down in recent decades. Because family investment companies are complicated structures for anyone unfamiliar with running a business, Tom O’Brien, assistant director at Brewin Dolphin, says that they are particularly good for business owners who are familiar with the processes of running a company.
When you set up a family investment company you will probably have to pay lawyers and accountants', and possibly financial advisers' fees, which can add up to more than £10,000. So it is probably not worth setting up a family investment company as a way of mitigating IHT unless the amount you plan to put in is well over the IHT nil rate band of £325,000 or £650,000 for a couple. Mr O’Brien says that you probably want to put in at least £1m for it to be worthwhile.
He also advises checking what your IHT position is likely to be in the future rather than just looking at how much money you have at present. If you plan to give a large amount of money to charity, meanwhile, or spend far more than you earn, your tax position might change.
You could set up a family investment company for a cost of less than £1,000 if you are comfortable with doing all the work yourself and know exactly what to do. But most people need to employ lawyers and accountants to set the company up.
Family investment companies can also be used in conjunction with trusts, so a portion of the company’s shares might be held in trust for the benefit of future grandchildren. The main benefit of a trust is that it can have beneficiaries that aren’t yet born, whereas shares in a family investment company have to belong to someone.
How to set one up
You need to register your family investment company with Companies House. There are typically two main structures for the share capital, as follows:
1. Parents or other family members hold voting shares with no or little economic value, and children/grandchildren hold non-voting shares with entitlement to income and capital.
2. Family members all have a minority interest. Practical control of the company is given to the directors, and reinforced through the governance structure by writing it into the company’s articles of association and supporting shareholders' agreement.
Deborah Clark, partner at law firm Mills & Reeve, says that one of the most common features of a family investment company is the use of different types of share classes to provide a flexible approach on the payment of dividends. She would also expect all family investment companies to have provisions for dealing with share transfers to ensure that ownership remains in the family.
Unless you are an expert in this field, it is sensible to take tax and legal advice from specialists familiar with family investment companies to make sure you set up the structure that is right for you. For example, you could make the structure really simple with model articles of association, but doing this would mean you miss out on many of the benefits of a bespoke company structure.
You also need to keep on top of ongoing reporting requirements. What you report depends on the activities of your family investment company, such as what assets it holds, when they are sold and when the company pays dividends. Requirements include preparation of accounts, an annual confirmation statement and accounts to file at Companies House, and the submission of the tax return to HM Revenue & Customs (HMRC).
If you set up a family investment company and gift shares to your children, they will not have to pay IHT on the value of their holding if you live for seven years after setting up the company.
The tax treatment of family investment companies can vary depending on their nature and holdings. But, generally speaking, rather than paying dividend and capital gains tax on investments held within the company, you pay corporation tax on company profits and shareholders are liable to tax on the dividends they receive. In some cases you might pay a shareholder a salary out of the company, which would be subject to income tax. Mr O’Brien says this could be done, for example, if the shareholder wants to get a mortgage.
Not all assets held within a family investment company are exempt from dividend tax, but most stocks are. This makes reinvesting dividends within the company tax efficient. With some assets, corporation tax is paid when they are sold, while the value of others is marked to market and you pay tax on any profit on them every year.
Holding high-yielding, low-growth stocks within a family investment company should be more tax efficient than high-growth, low-yielding stocks. However, the nature of a stock's return can be hard to predict – particularly given everything that has happened this year.
Ms Clark says that many family investment companies invest in companies that pay dividends because the dividends they receive are generally not subject to corporation tax, but there has been speculation that this favourable treatment of dividends may be changed.
Sarah Allatt, head of wealth planning advisory at UBS Wealth Management, adds that, depending on the assets within the company and the time frame in which cash is taken out of the company, the structure may not necessarily be tax efficient.
“Anybody setting up a family investment company should accept that on the annual tax charge basis there are just as likely to be disadvantages as advantages," she explains. "This structure could cost you more in tax each year [than if investments were in a general investment account]. But if you are clear about your reasons and they are mainly regarding succession, protection and IHT, then it is likely to remain an option as a long-term vehicle.”
Also, if corporation tax were to rise family investment companies would be less appealing.
|UK tax rates (excluding Scotland)|
|Tax||Basic rate||Higher rate||Additional rate|
|Capital Gains||10% (18% property)||20% (28% property)||20% (28% property)|
|Corporation||19% on company profits||19% on company profits||19% on company profits|
What are the risks?
The biggest risk is a change in government rules. Last year HMRC set up a Family Investment Companies Unit to conduct risk reviews of private companies used by family offices and high-net-worth individuals to manage their wealth.
“The tax affairs of family offices and the use of family investment companies are the new frontier in HMRC’s crackdown on ultra-high-net-worths," says Steven Porter, partner at law firm Pinsent Masons. "Setting up this new unit is a clear statement of intent – to ensure that HMRC maximises revenues from the UK’s richest families.”
While there is no indication that the rules will definitely change, if they do this could make the structure less attractive. For example, if the government removes some of the tax reliefs currently granted to assets within the company or increases corporation tax. Mr O’Brien adds that, generally, when rule changes are made these come into force pretty quickly so “probably by the time you’ve heard about it it’s too late to do much about it”.
You could also end up paying more tax than you need to. You pay corporation tax on company profits and dividend tax on personal distributions, but careful management of the company can lower your tax bill.
Family investment companies are unlimited companies that don't get the same protection from creditors as limited companies. While it’s unlikely that you will get any claims against you, if you invest in something where someone might make a claim against you, bear in mind an appropriate level of protection.