Author: Helena Luckhurst
This article is taken from Helena Luckhurst’s blog The Wealth Lawyer UK
If you want to give something away but retain some control over it, chances are that an English lawyer will tell you to use a trust.
I am a great fan of trusts but, let’s be honest, they have some potential drawbacks. For example, if an individual puts more than £325,000 into trust, a 20% Inheritance Tax (IHT) entry charge could be payable. Most trustees currently pay Income Tax at between 37.5% and 45% and Capital Gains Tax (CGT) at 28%, which leaves less after tax to reinvest. It is also very difficult to prevent beneficiaries interfering in the trust administration completely – the whole premise of a trust is that the trustees have to be accountable to the beneficiaries. Laudable but not always wanted.
In many cases, with proper tax planning and a carefully crafted trust deed, most of these potential drawbacks can be managed. But, let’s be radical and think the unthinkable, are there any alternatives to trusts out there? Cue the FIC (Family Investment Company).
Here’s an example of how a simple FIC might work. Mr and Mrs Smith want to give their two children, Tim and Tom, £450,000 each, but retain control over how they access the money. Rather than giving them £450,000 each, the Smiths could create a FIC – a regular company but whose purpose is to invest the money it receives by way of subscription. The Smiths can be the directors and control the investment activity of the company. They subscribe for shares. This is the clever bit as, by issuing ordinary shares, perhaps of different classes, and tailoring the rights attached to each class, the Smiths can craft the FIC around their own family’s requirements. They could subscribe for, say, £300,000 of ordinary ‘A’, ‘B’ and ‘C’ £1 shares. Voting rights would attach to the ‘C’ shares only. The Smiths then give the ‘A’ shares to Tim, the ‘B’ shares to Tom (these are Potentially Exempt Transfers (PETs) by the Smiths for IHT purposes) and the ‘C’ shares to a trust for Tim and Tom (this is a Chargeable Lifetime Transfer (CLT) but will not trigger an IHT entry charge unless the Smiths are in the habit of making gifts to trusts or companies). The Smiths can be the trustees. Appropriate share transmission restrictions prevent Tim and Tom selling their shares. The rights attached to the shares would allow the directors to determine when dividends were declared and on which class of share dividends were paid.
For tax purposes, FICs come into their own when the aim is for long-term retention of family money in the structure, not short-term distributions. There are two layers of taxation of course – taxation at the company level and taxation at the shareholder level. Broadly speaking, FICs that just invest in other companies’ shares receive dividends tax free, so gross roll up of dividend income is possible. Changes of investments will give rise to Corporation Tax, if they are standing at a gain on disposal, but currently payable at 21% with indexation allowance available (compared to 28% CGT and no indexation allowance for individuals). So more profit is available for reinvestment. Should the FIC pay dividends, a basic rate shareholder will have no further tax to pay – ideal for teens and twentysomething children perhaps. If a partial return of capital at some stage is envisaged at the outset, preference shares can be issued to the children as well, structured so that the timing of the redemption is at the directors’ discretion.
If a FIC’s constitution prohibits shares being transferred to non family members, the FIC should be an effective vehicle to prevent family wealth being lost to a child’s spouse on divorce.
If the family is prepared to take the risk, the FIC could be an unlimited company, thereby avoiding the need to maintain a record of the shareholders at Companies House and file accounts. If all the FIC is doing is investing on the stock market, the risk associated with unlimited liability should be negligible.
In the right situation, a FIC is worth considering. Why aren’t more lawyers talking about them?
Helena Luckhurst, Partner, Fladgate LLP (email@example.com)