Family investment companies – the death of the trust?

Trusts are less tax-favoured than ever before since the trust taxation changes and the introduction of the 50% income tax rate. Could family investment companies provide a better alternative for wealthy families?

Perhaps the most serious contender at present to replace the use of a trust in wealth and succession planning is the family investment company (FIC). This vehicle is simply a private company whose shareholders are members of the same family, and whose memorandum and articles of association can be drafted to suit the family’s needs.

Similar to a trust, this enables the founder to retain control over family investments, but FICs do not suffer the 20% entry charge or six per cent 10-yearly inheritance tax (IHT) charges applicable to trusts.

So what are the tax benefits of FICs?

Estate planning

In terms of estate planning, FICs have some attractive features.

  • There are no immediate IHT charges on transfer of property to the FIC, and no ongoing 10-yearly IHT charges.
  • Gifts of shares in the FIC to other family members will fall outside of the IHT net providing the donor survives seven years.
  • Shares in the FIC up to the value of the donor’s available nil rate band can be gifted into trust without triggering an immediate IHT charge.
  • A share class can be created into which future growth in value of the FIC passes, and these shares can be gifted to a trust or an individual with minimal tax charges.
  • If the donor holds shares on death, IHT will be payable, but the value of the shareholding is discounted to reflect its relative size (for example, minority shareholdings often attract significant discounts). In addition, it is possible to tweak the structure in certain circumstances in order that no IHT should be payable on death.

Tax within the FIC

The FIC will pay corporation tax – currently a maximum of 26%, falling to 23% by April 2014 – on income and capital gains generally. However, this tax charge can be mitigated to varying degrees by the fact that UK and most overseas dividends will not be taxable within the FIC, and it will also benefit from an indexation allowance on gains, meaning that only returns above the level of inflation will be taxed.

If profits are to be accumulated within the company, this makes FICs very attractive, as the rate of 26% or less compares favourably with personal and trust income tax rates of up to 50%.

Any downsides?

There are two main disadvantages of a FIC from a tax perspective.

  • Firstly, if capital assets, as opposed to cash, are transferred to the FIC then there may be a capital gains tax (CGT) charge on the transfer, although there are various ways in which this charge might be mitigated and specialist advice should be taken.
  • Secondly, there is a double tax charge when profits are extracted by shareholders, who may pay further tax of up to 36.11% on dividends – this can be mitigated to some extent using careful planning.

Is it for me?

While not offering the same degree of flexibility as a trust, FICs are nevertheless a credible vehicle for holding and passing down family wealth where the 20% trust entry charge can’t be avoided, or in circumstances where it is anticipated that profits are likely to be reinvested within the structure.

For further advice on FICs, contact with your local tax specialist or find further information on wealth planning on our Private client and Wealth advisory pages.