A wealthy individual (“Mr W“) has cash, investments or property worth £10m which he holds personally. This portfolio produces an annual income of £400,000 and historically has provided capital appreciation of 3% per annum.
On the basis that his income tax each year is likely to be in excess of £160,000 (with the majority being subject to the additional higher rate tax of 45%) and if he realises a capital gain on the uplift in capital value, his capital gains tax might be in excess of £80,000 (28% on gains of £300,000 if gains of 3% per annum are realised).In the event of his death, inheritance tax will approach £4m (at a rate of 40% after the nil rate band of £325,000). This will increase over a period if the value of the portfolio continues to increase. If Mr W lived for a further 10 years, the value of the portfolio could rise to £12.5m which might mean inheritance tax of £5m.
Formation of an FIC and the transfer of assets into it in return for a loan account produces a different scenario. The income and capital gains payable by Mr W would be replaced by corporation tax (currently at the rate of 19% but possibly reducing further) payable by the FIC. Mr W could withdraw monies from the FIC by reducing his loan account which would not be taxable. If Mr W were to live for a further 10 years and withdrew £250,000 per annum from the FIC, his loan account, initially £10m could reduce to £7.5m which could reduce the inheritance tax liability by £1m (if the current rate remains the same).
In addition, any increase in the value of the investment portfolio (helped by the lower rate of tax on capital gains) would accrue to selected shareholders rather than Mr W.
There is a good deal of flexibility when considering the selected shareholders of the FIC who would typically be all the family members.
The management and the shareholders do not need to correspond so that through the use of different classes of share capital it is possible for Mr W to retain control, whilst at the same time issuing different dividend-bearing shares or capital-bearing shares to the selected shareholders. The capital-bearing shares would benefit from any increase in value of the investment portfolio. Dividends can be routed to family shareholders who perhaps need income – this might include education and university fees. Control can be achieved by issuing shares to certain shareholders effectively giving them the right to determine the constitution of the board of directors and so have management control. Such shares might exclude the rights to any uplift in value or rights to dividends.
It is not all good news, however. There are administration costs involved in setting up a company and ongoing regulatory costs including necessary filings at Companies House and tax returns.
Accounts and documents setting out share class rights together with details of the shareholders need to be filed at Companies House which means that information relating to the family is in the public domain, although choice of a neutral company name perhaps mitigates against the risk of intrusive searches.
Furthermore, a new tax rate on dividends has been announced commencing on 6 April 2016 which will mean that it is more costly for selected shareholders to extract money from an FIC by way of dividend.
Also in the event that there is a change in legislation or a change in family circumstances, the winding up or liquidation of the FIC would lead to a double capital gains tax charge (both within the company and on the individual shareholders) to the extent that the investment portfolio has increased in value.
It may be worth looking at other options. Besides investments being held personally, in some cases it may be advantageous to use trusts, in which case trustees maintain the investments on behalf of family beneficiaries. This can be useful in conjunction with an FIC if, for instance, Mr W had infant grandchildren.
More esoteric are private unit trusts or open-ended investment companies (“OEICs“).These are quite costly from an administrative viewpoint but the main advantage is that the investments within such vehicles can be changed without liability to capital gains tax, although redemption of units by the unit trust or withdrawals from the OEIC are likely to be taxable.
There are family limited liability partnerships which may be useful if there are a number of beneficiaries who require regular distributions and are basic rate taxpayers (because of the limited liability partnership’s transparent tax status). Also unlimited companies may be useful because the filing requirements at Companies House for such companies are very much reduced. The consequences are that less of the family’s affairs are in the public domain and administrative costs are reduced. The benefit of limited liability is lost but if the investment strategy is prudent, this may not be a concern.
FICs will not be the answer in all cases where a family wealth preservation strategy is under consideration but they certainly merit examination in many instances. However, a close analysis of the family structure and the family’s obligations is required in every case in order to arrive at the best solution.
Please note this information is provided by way of example and may not be complete and is certainly not intended to constitute legal advice. You should take bespoke advice for your circumstances.