Diva Shah, Senior Associate, Kingsley Napley LLP
Family trusts have always been a traditional feature of estate planning, a well-known means of passing on wealth to the next generation and potentially reducing Inheritance Tax (“IHT”) on an estate. However, Family Investment Companies (“FIC”) have become increasingly more attractive over the last 10 years because of their structure and tax advantages. In the meantime, we have seen the popularity of trusts decline, perhaps due to their archaic nature, negative press coverage and a less sympathetic tax regime for trusts. Are FICs the new Trusts or is there room or both?
Traditionally, a Trust would transfer assets to the trustees to hold on behalf of and manage for the benefit of the beneficiaries. We would normally see the parents as the settlors and trustees with the children and grandchildren as beneficiaries. The Trust deed sets out the powers and duties of the trustees.
A FIC is nothing special; it is simply a private company that holds and manages investments for the benefit of future generations. There is no legal definition of a FIC, and FICs are not subject to special rules of their own.
Most FICs also have the following characteristics:
Day-to-day management carried out by the board of directors, usually the founders of the company.
Family members (and possibly family trusts) become shareholders, with each typically holding different classes of shares.
The different share classes will allow varying degrees of control and entitlements to dividends, capital and voting rights. The founding (or older) generation tends to retain voting rights, whereas the younger generation tends to hold income rights and the underlying capital value.
The articles of associate and shareholders’ agreements set out the rules for the company, ensuring the FIC can be run in the appropriate way for the family.
FICs are not trading companies. Instead, they hold investments, often in the form of cash, shares or property.
Possible ‘pros’ and ‘cons’ of FICs v. Trusts
In some ways, FICs and Trusts are similar:
The directors of a FIC, and the trustees of a Trust, are obliged to manage assets for the benefit of the underlying beneficiaries/shareholders.
Directors and trustees make day-to-day decisions concerning the management of the FIC/Trust and maintain a significant level of control.
Pros of a FIC
Control: Control can be retained by the founders by owning shares with voting rights in a number of ways. These include in their personal capacities as directors or shareholders or as the trustees of family trusts.
Inheritance tax on creation: A FIC can be set up without triggering an immediate lifetime IHT charge. By contrast, transferring assets to a Trust (in excess of the IHT nil-rate band allowance of up to £325,000 per person) can lead to an immediate lifetime IHT charge at 20% and may still result in a IHT charge if the settlor dies within seven years.
Ongoing IHT charges: Discretionary Trusts are subject to ten-yearly IHT charges at a rate of up to 6%, and proportionate charges on capital distributions when assets exit the Trust. FICs are not.
Capital growth: The class of shares issued to the founders often have limited rights to capital, ensuring the growth in the value of the FIC is attributable to other family members’ shares and outside the founders’ estates. This can be useful in relation to IHT planning.
Discounted value of shares for IHT: For IHT purposes, the value of individuals’ shareholdings can be discounted to reflect the number of shares held and the rights of the class of shares held. However, any loans made to the FIC, will remain an asset of the founders’ estates and provide no immediate IHT advantage (unless gifted).
Funding: A FIC can be funded in a number of ways; subscribing for shares, or making a loan. If a FIC is funded by way of a loan, the loan can be repaid to the founder, if and when appropriate. This has the benefit of the founders being able to retain access to some of initial capital (unlike trusts), with a tax-free return on capital to the founders (if the loan is interest-free) on repayment of the loan. Money or assets added to a Trust cannot usually be repaid to the founder.
Taxation of income and capital gains: A FIC’s income and capital gains are taxed at the corporation tax rate. This is lower than equivalent personal tax rates and the rates that apply to Discretionary Trusts. This can allow an FIC to accumulate value more quickly than a Trust. Dividend income received by FICs from other companies can be tax free if relevant conditions are met.
Next generation: FICs may offer greater scope for inducting the younger generation into the management of family wealth. For example, the younger generation can be involved as shareholders before becoming directors.
Familiarity - Trusts are often an unfamiliar concept. However, those who are used to running companies have a greater understanding of the terminology surrounding FICs and the requirements for the day-to-day management, often making them a more attractive proposition.
Cons of a FIC:
Setting up: It costs more to set up a FIC than a Trust. Setting up a FIC is a more involved process, requiring professional advice from private wealth and corporate solicitors and specialist accountants.
Capital gains tax on creation: If a FIC is funded by transferring non cash assets to the FIC, there may be a capital gains tax (charge. In contrast, on transferring assets to the Trustees, the settlor may have the option to claim holdover relief.
Double taxation of income: Whilst a FIC is an efficient vehicle for accumulating profit, when looking to distribute those profits to shareholders by way of dividend, there is an element of double taxation(Corporation Tax is charged on (non-dividend) profits and income tax is charged on the dividends paid to the shareholder). If the main objective is to accumulate value within the FIC, this can be done efficiently and may outweigh the double taxation in the long run.
Compliance: FICs are subject to public reporting requirements. However, the gap in reporting requirements between FICs and Trusts has narrowed recently since most kinds of Trusts need to register with HMRC’s Trust Registration Service.
Who can benefit: A FIC can only distribute money to its shareholders. By contrast, Discretionary Trusts can have relatively wide classes of beneficiaries. This issue can be easily solved by holding FIC shares in a Discretionary Trust.
Winding up: Generally, FICs cannot be wound up as easily as Trusts.
FICs and Trusts can both be utilised for efficient protection of family wealth and both have a place within a succession plan. It may also be worth considering a combination of structures for the most efficient outcome; for example, trusts can hold shares in a FIC for the longer term benefit of children and unborn family members.
Very generally, Trusts lend themselves to smaller funds or IHT-relieved assets and where flexibility and asset protection are key aims and access to assets may be necessary in the short term. FICs tend to be recommended for those with a very significant exposure to IHT, large cash or capital deposits, long term generation wealth planning and those who are more familiar with running companies.
Trusts were traditionally seen as the most appropriate way to achieve clients’ objectives despite the increased tax costs and greater running costs. However, depending on a client’s assets, overall wealth, family circumstances and objectives, FICs can compare very favourably with Trusts. With the ability to transfer limitless assets into a FIC without an IHT cost, FICs can be a very effective IHT planning structure providing control and flexibility and are coming to replace the role once occupied by trusts in the tax strategies of wealthy families.
There is no ‘one size fits all’ to succession planning. There are advantages and disadvantages of both options. Every succession plan should consider the client’s needs, objectives and particular circumstances as well as the short term and long term goals. Professional advice is key: it ensures the unique situation is considered at the outset and the best model, tailored to the client’s specific circumstances and needs, is implemented correctly.
