UK: The Family Investment Company

Last Updated: 2 February 2012
Article by Howard Bilton

UK Inheritance Tax is a major issue for anyone UK domiciled or with assets within the UK.

Those who are UK domiciled will be subject to UK Inheritance Tax (UK IHT) which is charged on the total value of their worldwide estate at a rate of 40% - although the first £325,000 is exempt. For those with a relatively modest worth of £1,000,000 this results in an IHT bill of over £270,000.

It could be said that this tax is voluntary as it is relatively easy to avoid if the taxpayer is willing to gift assets to another individual such as a family member at least 7 years before death (this is known as a PET) or by settling an amount equal to his nil rate band every 7 years into trust. However if the donor attempts to continue to use or enjoy the property in any way both strategies are exposed to the gift with reservation of benefit regime (the "GROB" regime) and HMRC will often be able to apply the UK IHT charge.

Now is there is another solution which allows the control of assets to be retained whilst their value, or most of it, is transferred.

A standard company is limited by shares but it is possible for a company to be limited by guarantee (Guarantee Companies) or by both shares and guarantee (Hybrid Companies). Guarantee companies are often used to form a society, club or private foundation.

Normally there are three characteristics attached to either the share or the membership being:

  1. Votes
  2. The right to receive income in the form of dividends
  3. The right to capital i.e. ownership of the underlying assets

It is, however, possible to create shares or memberships which carry only one or two of these characteristics rather than all three. By assigning different characteristics to different classes of share or membership it is possible to create very interesting results.

The FIC can be created to achieve the total elimination of UK IHT and might also be used to give substantial income and capital gains tax advantages.

PLANNING AGAINST UK IHT

Assets transferred into a discretionary trust are exempt from UK IHT provided the settlor is excluded as a trust beneficiary. But there are other problems with this planning. The settlor can only transfer assets up to the value of his nil rate band and annual exemptions (£331,000) every 7 years unless he is prepared to pay a 20% charge on the excess and the trust fund will be subject to the anniversary charges every ten years from when the trust was established. The charge can be as high as 6% of the value of the trust property on the date of the anniversary. For these reasons most taxpayers find setting up a discretionary trust an unattractive proposition.

The other way to avoid UK IHT is to give away assets at least seven years before death. This too is rarely attractive as most do not wish to rely on others for their upkeep, do not know when they are likely to die and so are reluctant to give away wealth which they may later find they need. Most would like to remain in control of their own destiny and their own assets. They are not necessarily in need of the capital but do frequently want the income generated on those capital assets and to dictate the way those assets are dealt with and invested. Outright gifts do not achieve this objective. If the taxpayer continues to use or benefit from the assets he has "given away" those assets will be deemed to form part of his estate on death under the GROB regime. Thus this type of planning is often completely ineffective and can end up being more costly in the long run (for instance the gift of the asset may have triggered a capital gains tax charge and yet no IHT saving is realised).

With careful planning the FIC is able to overcome these problems.

Although the structure of the FIC has unlimited variations a typical scenario might involve the patriarch of the family transferring substantial amounts of wealth into the FIC in return for its shares which might be divided into three different classes:

  • Class A shares which carry votes but no right to capital or income
  • Class B shares which carry rights to income but no votes and no right to capital
  • Class C shares which carry no votes and no right to income but all rights to capital

The patriarch would initially hold all the shares and therefore there is no chargeable transfer as assets have simply been exchanged for the shares with no resulting loss to his estate.

The Class C capital shares can be gifted to family members in proportions decided upon by the patriarch. The substantive value of the underlying assets is thereby transferred and as long as the patriarch survives that transfer by seven years UK IHT is completely eradicated.

The Class B income shares can be retained by the patriarch. They will have an assessable value but it will be minor or insignificant when compared to the value in the Class C capital shares.

The Class A voting shares have no assessable value but allow the holder to control the FIC and thereby dictate what happens to the assets owned by the FIC, the way those assets are invested, the timing of any income distributions and everything else to do with the company. The patriarch can therefore continue to administer "his" assets without interference and continue to enjoy the income but will have given away the substantial value which is inherent in the Class C capital shares. UK IHT is therefore eliminated or reduced appropriately.

Other variations of the above might include giving away some of the income producing shares as well if it becomes clear that the patriarch has no need for the full amount of the income. Elder family members could be given some say in the administration of the assets by transferring a proportion of the Class A voting shares to them. It may also be possible for the patriarch to transfer the income producing shares into an offshore trust. If the patriarch / settlor is married it would be possible for him and his wife to each transfer income shares with a value of up to £331,000 into trust without an IHT charge. Provided the settlor and his spouse are excluded as a beneficiaries the income from the shares could be rolled up tax free and reinvested offshore. The shares would fall outside of his estate on death as would the other trust assets and no tax would be visited on the beneficiaries until and unless they actually received the income by way of distribution out of the trust. So this may be more advantageous then an outright gift of those shares which would mean all income being taxable on the shareholder when it actually arises.

In another variation, the company is initially created with the votes attaching to memberships rather than shares and the FIC has a Committee, like a club committee, who have the right to allow new persons to become members and to expel existing members. The patriarch would control the Committee. A responsible person might be granted membership and therefore will have a say in the running of the FLC but if the Committee so rule that member can be removed from membership.

TAX EFFECT

Those who are UK resident and domiciled would and hold the Class B income shares, according to current UK legislation, remain taxable on the underlying income and capital gains generated by the company even if it was not paid out as dividend. This is due to various anti-avoidance provisions designed to prevent a transfer of assets from producing tax advantage so in its simplest form, this structure will not give any income or capital gains tax advantage to an UK resident and domiciled person and is purely a method of reducing or eliminating UK IHT. UK resident and domiciled persons can gain income tax advantages by having the Class B income shares transferred to a suitable holding structure such as the trust described above.

For those who are UK resident but not UK domiciled and have elected to be taxed on the remittance basis, the FIC would defer or avoid income and capital gains tax unless and until income was paid out and remitted to the UK.

If income and capital tax advantage is sought the management and control of the FIC becomes a crucial issue. Most onshore countries have provisions within their tax legislation whereby any company, no matter where it is incorporated, which is managed or controlled from within their jurisdiction will be tax resident there and taxable on its worldwide income at local rates. Any offshore company which had UK based directors would be tax resident in the UK and subject to UK tax on its worldwide income. Failure by the directors to declare the liability of the offshore company to UK tax would be an offence with potentially very serious consequences. To avoid this tax effect we can provide professional third party directors and in most cases it is essential to take this service if income and capital gains tax savings are sought. If on the other hand the FIC is to be used only to make UK IHT savings the patriarch can manage and control the company from the UK and it will be tax neutral i.e will not give income and capital gains tax advantage but will not be disadvantageous either.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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