Mr. Smith has been a client of Dixcart’s for many years and he wants to explore the options available to provide financial help to his children, as they get older and start their careers. The children are all in their teens, with the eldest just about to start university. Mr. Smith wants to ensure that they make considered future decisions financially and do not take the opportunity to have a series of ‘gap years’.
Mr. Smith runs his successful logistics company with his wife, who takes more of a background role. They have built up an investment portfolio and own four residential properties, acquisition of the final two was partly funded by borrowing. All of their assets are jointly owned.
Mr. Smith is already thinking about planning for the future and ways in which he might be able to mitigate future inheritance tax (IHT) obligations.
Family Investment Company – What Is It?
Family Investment Companies (FICs) are companies limited by shares (an “Ltd” or “Limited”) and often established by parents and/or grandparents (“Founders”) to benefit themselves and their family, as shareholders. The popularity of FICs has increased over recent years, and they are viewed as a corporate alternative to a discretionary trust.
Summary of Current Status
A summary of the current situation and the assets owned by Mr. and Mrs. Smith are as follows:
- Mr. Smith’s annual income is approximately £150,000. His wife is a higher rate taxpayer;
- Company shares are held equally by Mr. and Mrs. Smith and will qualify for 100% business property relief;
- In the event of a sale both Mr. and Mrs. Smith would qualify for business asset disposal relief;
- The investment and rental properties portfolio are currently worth £3.5 million, their main residence is worth £1 million, and they have recently inherited £1.5 million.
What Are the Potential Advantages of a Family Investment Company?
At a high level the potential advantages of using a FIC can be summarized as follow:
- Income retained within the FIC (primarily rental and dividend income) would attract lower rates of tax (up to a maximum of 25%), in comparison to Mr. Smith’s marginal rate of 45% (39.35% for dividends) and Mrs. Smith’s marginal rate of 40% (33.75% for dividends);
- If the two rental properties that are subject to a mortgage can be transferred to the FIC, a significant advantage would be that full interest relief would be available although this would likely give rise to SDLT charges which would have to be considered;
- Mr. and Mrs. Smith could make potentially exempt transfers of value that would become fully exempt if they survived for at least seven years, so that their estates on death would benefit from the full IHT nil rate bands;
- Future increases in the value of the investments owned by the FIC would increase the value of the company’s shares. The children’s shares would therefore increase in value outside their parent’s estate. The application of minority discounts might also mean that the total monies subject to IHT were reduced;
- Dividend payments could be directed to the children whilst they were still at university and likely to be non-taxpayers, or when they were basic rate taxpayers.
Mr. and Mrs. Smith would retain full control of the company’s assets and could decide on dividend payments.
Are There Any Potential Negatives in Using a Family Investment Company?
It must be remembered that there will be double taxation of income/gains paid out to shareholders, particularly where the shareholders pay tax at the higher rates.
In addition, care needs to be taken with dividends paid to children whilst they are minors such that they are not assessed to tax on Mr. and Mrs. Smith.
FICs do not qualify for many CGT and IHT reliefs.
Finally, that there will be administrative obligations and costs associated in running the company.
Mr. and Mrs. Smith decide that they want their children to benefit from their recent inheritance of £1.5 million and the increases in value of certain of their investments. They therefore decide that they will use the inheritance to subscribe to shares in the company, most of which will then be given to the children, and that they will also transfer some of their assets to the company, leaving the consideration for those transfers outstanding on a loan account owed to them.
The assets to be transferred will be chosen to minimise tax liabilities and maximise future tax savings. The share portfolio has been managed carefully and investments have been bought and sold relatively frequently, partly to use the CGT annual exemption. It will therefore be possible to identify shares that can be transferred without giving rise to a capital gain. There will, however, be stamp duty payable at 0.5%.
Mr. and Mrs. Smith also decide to transfer the investment properties that are subject to a mortgage, so that full interest relief can be obtained. As they were recently acquired there will be no capital gain, but there will be stamp duty land tax to pay.
Structure of the Company
Mr. and Mrs. Smith will be appointed as directors, and will each be issued one ‘A’ ordinary share. This will mirror their current 50:50 ownership of assets.
Three further classes of ordinary shares (B, C and D) will be created for the three children, which will have no voting rights but entitlement to dividends, as declared on that particular class of shares, and ranking equally with the ‘A’ ordinary shares, as to entitlement to capital.
This will enable dividends to be paid to the children as required, once they reach 18, but will also mean that the capital value of their shares will increase, as the value of the company increases.
Mr. and Mrs. Smith, will initially subscribe to all of the shares but will then give the B, C and D shares to their children. The initial value of the company will be equal to the amount of cash subscribed, the other properties having been transferred to the company at full market value.
If the shares are transferred immediately there will be no CGT consequences, and no stamp duty as it is a gift.
In order to ensure that most of the initial value passes to the children, 100 shares of each class (B, C and D) will be created in order to swamp the A shares. This will ensure that value is transferred by way of a potentially exempt transfer. We would always recommend that that professional valuation advice be taken before proceeding.
This case study examines one particular set of circumstances. The concepts would be the same in other situations but detailed professional advice should always be sought.
For additional information, please contact Paul Webb at Dixcart UK: firstname.lastname@example.org.