Could a family investment company cut inheritance tax?

Trusts are the standard way to pass down family wealth to future generations. But recent tax changes mean that family investment companies may offer a more tax-efficient option…

The Finance Act 2006 introduced significant changes in the UK's tax regime for trusts. Most new trusts now enter into the relevant property regime which result in:

  • An immediate charge to inheritance tax (IHT) at 20% for transfers made in excess of a donor's available nil rate band (currently £325,000
  • 10-yearly IHT anniversary charges (capped at a rate of 6%)
  • Further charge to IHT if assets 'exit' the trust (also capped as above).

With these drawbacks individuals wishing to pass down substantial wealth need to consider alternative vehicles, which may be more tax-efficient. This is particularly topical at the moment due to the increasingly competitive rates of corporation tax available in the UK (20% from 1 April 2015) and whether it is possible to use a company as a vehicle for passing down family wealth.

What is a family investment company?

A family investment company (FIC) is a UK-resident private limited company whose shareholders are family members. This vehicle can be extremely tax-efficient where an individual transfers significant sums of cash into a company. This cash could be invested to generate income for the family.

Five benefits of a family investment company

1. Assuming that an individual has available cash to transfer into a company, the transfer into the company would be tax-free.

2. There would be no immediate charge to IHT on the gift of shares from the donor to another individual as this is deemed to be a potentially exempt transfer (PET). There will be no further IHT implications on the donor if they survive for seven years following the date of gift.

3. The donor can still retain some element of control in the company providing the articles of association are carefully drafted.

4. The company would only pay tax at a rate of 20% on the profits that it generates.

5. Shareholders only pay tax to the extent the company distributes income. If the profits are retained within the company therefore, no further tax would be payable.

Four disadvantages of a family investment company

1. If non-cash assets are transferred into the company, the donor may be incur a capital gains tax (CGT) charge at a rate of 28% based on the market value of assets that are transferred into the company at the date of transfer.

2. Trust structures continue to be tax-efficient if you can transfer assets in without incurring an IHT charge. This is achievable when assets qualify for some sort of relief such as business property relief or agricultural property relief. If an individual has these assets therefore, a trust structure may be more suitable. Read our recent post on discretionary trusts and tax for further information.

3. As mentioned above, there is an element of double taxation in using the company structure. The profits are first subject to corporation tax at a rate of 20% and then are subject to income tax when they are subsequently distributed to the shareholders, albeit accessing capital through a purchase of own shares can be highly tax-efficient in some circumstances.

4. The company will have to comply with company filing regulations – there are costs to consider when setting up and running a trust.

With the attractive corporation tax rates a family investment company is something that should be seriously considered as an alternative to a trust. A FIC still allows the donor to retain control over their investments while avoiding an immediate charge to IHT. Care does need to be taken, however, if assets other than cash are to be transferred into a family investment company.