Trusts v FICs: which is best?

Helena Luckhurst, Partner, Fladgate LLP (hluckhurst@fladgate.com)

Is a company or a trust the best vehicle to hold family money?

Companies can be used to hold family wealth. Often referred to as Family Investment Companies (FICs), at their simplest they can be seeded with funds by subscribing for shares or, if continued access to family wealth is needed, by way of loan (with any growth in the invested loan funds being the FIC’s assets).

It’s difficult to be precise about the benefits of using a FIC because they are often highly personalised, being built ‘from the ground up’ to meet a family’s particular requirements. However, some general themes emerge:

• Control: generally they offer a way for senior family members to use wealth to benefit younger family members in a controlled way, as the use of ‘alphabet shares’ (different classes of shares, with the seniors holding voting shares (and often acting as directors), and the more junior members each holding a different class) allows dividends to be paid at different times.
• Long term wealth holding/ Income Tax mitigation vehicle: the fact that FICs do not usually pay any tax on dividends, coupled with low rates of Corporation Tax for other income, can make FICs an extremely attractive tax wrapper for investments, when compared to individual ownership; less tax means more available for reinvestment. However, the shrinking dividend allowance and dividend rates of taxation for shareholders mean that FICs really come into their own if regular distributions are not needed or the shareholders have limited other personal income – good for grandparents wanting to pay school fees perhaps.
• Inheritance Tax (IHT) planning: many people are put off from making significant lifetime gifts because they cannot be sure that they won’t need access to their capital and the income it generates again. FICs provide answers in this respect because if you think you may need capital back again, you can fund the FIC by way of a loan. If you think you may need income, retain A shares, to which all dividend rights attach. It’s difficult to achieve successful income shearing with a trust and avoid reserving a benefit for Inheritance Tax purposes.
• Asset protection: it’s harder for disgruntled ex-spouses of FIC shareholders to access the FIC’s assets, provided the FIC’s governance documents contain pre-emption rights preventing FIC share transfers other than to core family members. Minority shareholdings with limited rights will always be valued at a discount relative to the company’s assets.

A key disincentive to using trusts is the 20% IHT entry charge on assets passing into trust in excess of the individual’s IHT Nil Rate Band. This effectively limits couples to putting in no more than £650,000 into trust every seven years, unless the assets qualify for an IHT relief.  In contrast, gifts of FIC shares to family members are not immediately chargeable for IHT, so the 20% upfront charge is avoided, provided the giver can manage to survive seven years.  FICs also do not suffer IHT periodic charges.

Given that trusts are taxed at higher rates than FICs on many fronts, is there anything to be said for using trusts? In my view, the answer is definitely yes.  Firstly trusts, particularly if discretionary in nature, offer total flexibility of income and capital allocation between beneficiaries – FIC shares, once given away, cannot be recalled.  Secondly trusts can last for up to 125 years and, as such, they are truly an intergenerational IHT mitigation planning tool.  Provided there’s a plan for dealing with IHT periodic charges, at least three generations’ worth of 40% IHT charges can be avoided with a trust.  An appropriate investment policy can usually counter the higher Income Tax and Capital Gains Tax rates that trustees face.  But with a FIC, where children are the shareholders, only a single generation’s (i.e. the parents’) 40% IHT liability is potentially avoided.  The FIC shares are still IHT taxable assets in the hands of the shareholder children.

Ultimately the arguments for and against are more nuanced than space permits me to elaborate on here, but the point is that structuring family wealth is always worth a conversation.