Kind Wealth are able to advise on the underlying investments held within a Family Investment Company.
In recent years, Family Investment Companies have become a more popular vehicle for the High Net Worth Individual as a useful tool for tax and succession planning.
What is a Family Investment Company?
A Family Investment Company, sometimes referred to as a FIC, is a company that invests rather than trades. The investments can be in company shares and property, as well as many other types of investment.
The Family Investment Company is set up by the founder transferring cash or assets, quite often by way of a loan. Any profits arising from the investments are taxed at corporation tax rates rather than income tax or capital gains tax rates. This can create a tax saving of over 25% for an individual paying tax at the additional rate of 45%. However, this tax saving is expected to reduce to 20% in April 2023, as the rate of Corporation Tax is expected to increase to 25%.
The Family Investment Company structure offers Inheritance Tax advantages, which can make it an attractive alternative to a trust. Whilst trusts often have Inheritance Tax advantages, the level of tax is typically higher for trusts, compared to a Family Investment Company.
How is a Family Investment Company Set Up?
Typically, a Family Investment Company is established with a founder share class held by the individual(s) providing the capital, either by a cash loan or by transferring assets into the company. Transferring assets can have separate tax consequences, such as capital gains tax and when it comes to property, stamp duty land tax. These tax implications can render the creation of the Family Investment Company prohibitive.
On creation, other family members and often family trusts become shareholders. Different classes of shares are typically issued to enable the company to pay different dividends to different people.
The founding shareholder generally maintains control over the investments and the payment of dividends. The Articles of Association and the shareholders agreement can be drafted to protect the shares from sale to individuals outside of the family, which also makes this type of structure more effective in a divorce.
What are the Tax Implications?
Corporation Tax
Profits arising within the Family Investment Company are chargeable to corporation tax, currently 19% in the 2022/23 tax year. However, from April 2023, the rate of corporation tax may increase to up to a maximum rate of 25%.
Where the Family Investment Company holds equities/company shares, there may be no tax at all as dividend payments are often tax free from company to company. This can increase the return on the investment significantly.
Family Investment Companies are not just used for equity portfolios. Since the tax rules for residential property have changed in recent years, making the holding of property portfolios less tax efficient if holding them on an individual basis, it is becoming more common for investors to use Family Investment Companies to house their property portfolios. The rental profits in the company are taxed at preferential corporation tax rates and companies still have the ability to deduct any loan interest from the rental income, which has now been restricted for personal investors.
Income Tax
The investment is usually made by way of a loan to the company and this can be repaid from the profits tax-free. Although, it should be noted that HMRC have been known to challenge the tax treatment of repayments of interest-free loans when it comes to Family Investment Companies.
The Family Investment Company wrapper shelters the investments from income tax until the funds are extracted from the company. When the profits are extracted, the shareholders will be liable to income tax on any amounts received. Payments would usually be made by way of a dividend and are subject to income tax at the respective dividend tax rates, as follows:
| Income Band | Dividend Tax Rate | Income Tax Rate |
|---|---|---|
| Basic Rate Tax Band | 8.75% | 20% |
| Higher Rate Tax Band | 33.75% | 40% |
| Additional Rate Tax Band | 39.35% | 45% |
Each individual has a dividend tax allowance of £2,000 per annum. Dividends received within the dividend allowance are tax-free.
The Family Investment Company is created to benefit the family and, as such, parents and children are generally included as shareholders. It is also possible to include a trust, such as a family trust, as a shareholder to offer more flexibility.
Dividends paid to minor shareholders are taxed as if the parents had received the dividend directly. However, for children over 18, payment of a dividend up to the basic rate band can be a very efficient way of extracting funds to help with costs, such as university fees.
The Family Investment Company structure is of most benefit when the capital and income can be retained within the company for long periods, or indeed used as a structure to pass on to the next generation.
Capital Gains Tax
Any assets sold within the Family Investment Company would be taxed at corporation tax, rather than capital gains tax.
If the family wanted to extract the profit from an investment out of the company, then the profit would have to be extracted from the company by way of dividend and would be taxed in the same way outlined above.
On the sale or liquidation of the Family Investment Company, the shareholders would be charged to capital gains tax on the value of their shares less any cost. As the shares are likely to have been subscribed for at par value, Capital Gains Tax would likely be charged on the whole increase in the value of the company.
Inheritance Tax
One of the main advantages to a Family Investment Company are the Inheritance Tax benefits. Not only is the value passed to the other shareholders on the creation of the company free of inheritance tax (subject to surviving seven years) but any increase in the value of the investments is immediately outside of the founder’s estate, and is therefore, free of inheritance tax.
Any further shares in the company can be passed on at a later date, potentially via a trust. As the value of the founder’s shareholding drops as it is gifted away, the founder’s exposure to inheritance tax reduces further.
What are the disadvantages of a Family Investment Company?
Tax laws can change and they can be changed retrospectively. To minimise the impact of this potential risk, make sure you review your Family Investment Company’s structure regularly with your lawyer and accountant, to keep up to date with any changes.
There are costs involved in setting up a Family Investment Company. Solicitors and accountants will need to be involved in setting up the company, which bring about additional costs.
If you’re transferring property into the company rather than cash, this could result in capital gains tax on the transfer of the property and potential stamp duty to consider.
How do you know if it’s right for you?
Family Investment Companies work best for those with a substantial amount of money to invest (for example, in excess of £1 million) and who are willing to keep it in the investment to grow, rather than take the money out on a regular basis.
Family Investment Companies are also a good option for those who want to avoid a large inheritance tax charge and also retain control over their investments, especially if their children are young.
As an alternative, trusts can be used to reduce inheritance tax charges and usually cost less to establish.
In some cases, it’s also worth considering an outright gift. Although this offers no control or protection over your assets, it may be appropriate for those seeking a simpler way to pass their wealth onto older and responsible children. However, make sure you are aware if there are any inheritance tax or capital gains tax implications.
Please note:
The Financial Conduct Authority does not regulate on the following: Family Investment Companies, Tax Planning, Estate Planning, Trusts and Inheritance Tax Planning.
Investing in property can be both high risk and difficult to sell.
Tax treatment varies according to individual circumstance and is subject to change.
The value of investments can fall as well as rise. You may get back less than you invested.
Sources:
Family Investment Companies | Crowe UK
Family investment companies (pruadviser.co.uk)
Family Investment Companies – the pros and cons – Taylor Vinters