To keep more of their money out of HMRC , wealthy families are increasingly using family investment companies But what are these agreements and how do they operate?
Wealth managers and accountants, who provide professional advice to extremely wealthy people, are observing a change in the way their clients wish to handle their affairs. Family Investment Companies (FICs) are receiving more inquiries as a means of transferring wealth with the possibility of paying less in taxes.
According to accounting firm RSM, families are now thinking about transferring assets to the next generation earlier than they may have otherwise intended as a result of the Autumn 2024 Budget announcements on inheritance tax (IHT). Family investment firms can help with this.
According to RSM partner Chris Etherington, trusts have traditionally been the go-to option. However, the possibility of upfront tax charges that can result in a 20 percent IHT liability, especially on larger gifts into a trust, has made trusts more difficult to administer.
In another method to avoid inheritance tax, gifts of shares made through a family investment company do not require this upfront payment. In our experience, the use of an alternative vehicle, the family investment company (FIC), has increased, while the use of trusts has steadily decreased since 2006, when then-Chancellor Gordon Brown introduced the 20 percent upfront IHT liability for trusts, according to Etherington.
"Changes to capital gains tax business asset disposal relief and the forthcoming changes to IHT business and agricultural reliefs have forced business owners to reconsider their family wealth succession plans," concurred Ben Handley, private clients tax partner at accounting firm BDO.
When it comes to their overall wealth succession plan, business owners may find it appealing to convert an existing trading company into a FIC in certain circumstances.
Family investment companies: what are they?
Families can hold, invest, and distribute their wealth through a private company called a family investment company, or FIC.
Parents are typically both directors and shareholders, with one share class maintaining voting control. Children and grandchildren, on the other hand, own distinct share classes with little to no voting rights but the ability to receive dividends and capital gains.
Due to the expenses and management required to establish and maintain them, family investment companies are typically best suited for investment portfolios of at least £5 million, according to Six Degrees Wealth Managers' experience.
"But in some cases, it might be appropriate for smaller sums," stated Katherine Waller, a co-founder of the company.
The corporate tax rates that apply to assets held within a FIC are 25 percent corporation tax and dividend tax rates of 8 to 75 percent at the basic rate, 33 to 75 percent at the higher rate, and an additional 39 to 35 percent. These rates may be preferable to those that apply to personal tax rates.
Although FICs are sometimes mistaken for trusts, they are entirely different legal arrangements. Companies are normally owned and managed by shareholders, whereas trustees own the assets of a trust.
"While holding assets in a company allows asset owners to retain control and ownership, settling assets into a trust usually entails giving away assets and control," Waller explained.
Why would you start a family-owned business for investments?
Creating a family investment business has several benefits.
1. inheritance taxes.
Family investment firms are effective from the standpoint of inheritance tax since they can take money out of the parents' estates that might otherwise be subject to 40% IHT, even though this liability is passed on to a different family member.
Inheritance tax treats gifts of shares through a family investment company as potentially exempt transfers (PETs), similar to a transfer into a trust. This indicates that, if the donor lived for at least seven years after making the gift, the gift's value would be excluded from their estate for IHT purposes.
Alltrust Services' managing director, James Floyd, stated: "The appeal makes sense. FICs give parents the ability to retain control over the value of their assets while freezing it for inheritance tax purposes. The transferred value immediately starts to accrue seven years of IHT.
2. . Asset safeguarding.
Beneficiaries' shares are kept apart from their individual financial situations, providing them with protection from creditors or divorcing spouses.
3. Better for business owners.
Working with many entrepreneurs, Six Degrees finds that they are more at ease with a company structure than with a trust.
"A business has a tangible feel. Board meetings can be conducted, investments can be reviewed, and the next generation can be included in decision-making. It's a terrific way to responsibly divide ownership and involve the various family members who have the money," Waller said.
4. maintaining authority.
A key demographic for FICs consists of wealthy parents who understand the benefits of gifting assets to manage their inheritance tax liability but are hesitant to give their children large sums of money and prefer to keep control.
5. effectiveness of taxes.
Since corporations typically do not pay corporation tax on dividends received from shares held, holding investments in businesses can also be tax-efficient.
Children can easily receive dividends from their parents if they are given different share classes. These dividends are taxed at the children's marginal rate, which is typically low (basic rate) or zero (within the personal allowance). For instance, this might be helpful in paying for college tuition. "This approach can be extremely tax efficient if they are not earning an income themselves," Six Degrees Waller stated.
6. flexibility.
Additionally, wealthy families can move their money around with flexibility thanks to FICs. They make it possible to lend in assets through redeemable preference shares, which allows the initial investment to be paid back tax-free.
What benefits and drawbacks do family investment firms have?
Benefits.
"Control is the biggest advantage," Waller stated. "The corporation pays corporation tax on income and gains, which can be lower than personal tax rates, and parents can retain their voting rights while progressively transferring value to their children. Additionally, it is flexible in that you can choose how profits are distributed, lent, or reinvested.
Drawbacks.
Complication is the opposite. Effective governance, accurate accounting, and a well-defined strategy for releasing funds are all necessary. This structure is not set-and-forget. Therefore, Waller advised, "it's important to go in with eyes open and see it as part of a bigger family strategy, aligned with the wealth's purpose, rather than simply a tax play."
What is the setup cost for a family investment business?
Setting up a family investment business costs tax advisors between £15,000 and £25,000, according to Six Degrees experience.
According to pension company Alltrust Services, continuing compliance annual accounts, CT600 returns, and confirmation statements at Companies House are probably going to add 2,000 to 5,000 per year.
"To get the structure right at the start, it's an investment of time in addition to the monetary cost," Six Degrees Waller said. "The simplest part of starting a business is actually incorporating it in a single day. The difficult part is correctly designing it. How decisions are made, who receives growth shares, and who gets voting shares. That's where the value is.
Two taxes?
Family investment firms appear to have a lot to offer. They also face "brutal taxation," according to some experts, which makes them less appealing to many families financially.
"The structure has double taxation: profit-based corporation tax is 25 percent, and dividend income tax is 8 percent for basic rate taxpayers, 33 percent for higher rate taxpayers, and 39 percent for additional rate taxpayers. Floyd of Alltrust Services, a pension firm, stated that this results in a substantial tax drag on investment returns.
But according to David Denton, a tax specialist at the wealth firm Quilter Cheviot, the way FICs are set up and invested can alter the conversation about double taxation in a number of ways.
For instance, not every profit made by a business's trading or investments is subject to taxation. This is due to the fact that most dividends paid on stocks owned by another business are not subject to taxes. The internal effective rate of tax can be significantly lowered by an investment strategy that favors shares with high dividend payments, he said.
FICs may also be fully or partially financed through loans. Repayments of the founders' loans are tax-free if properly structured.
As previously stated, taxable dividends may be included in the tax-free personal and dividend allowances of grandchildren who own shares in the class.
Lastly, Denton stated, "it is possible that capital gains tax, which is due at a maximum of 24 percent, may be due on the final wind-up of a company instead of dividend taxation, which is due at a maximum of 39.35 percent."
An alternative to family investment firms is a family pension trust.
The family pension trust is a viable substitute for a family investment company that accomplishes the same governance and succession planning goals with possibly better tax treatment.
"The taxation advantages to a FIC are substantial and immediate," Floyd stated, referring to the FIC's establishment through a Sipp or a small self-administered scheme (Ssas).
He noted that the 25 percent corporation tax that FICs must pay is eliminated when pension investments grow entirely tax-free. Using pension income rules, money can be taken out tax-efficiently, avoiding the dividend tax that can drive up the cost of FICs.
Floyd added that contributions "provide an instant boost that FICs cannot match, as they attract tax relief up to 45 percent."
Although they are currently exempt from estate taxes for IHT purposes, any unused pensions will be subject to inheritance tax starting in April 2027.
Floyd stated, "FICs may represent the most suitable structure for business owners looking to hold trading assets or property not qualifying for pension investment."
The family pension trust provides significantly better results for families whose main goals are succession planning, long-term wealth preservation, and tax-efficient transfer to the following generation. The economic equation is changed by the tax savings alone, which include avoiding both the 25 percent corporation tax and the dividend tax while receiving contribution relief.
Pensions' primary drawback is, of course, that they do not permit access to capital prior to age 55, which quickly rises to age 57. Additionally, the amount that can be contributed to a pension has limits.
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