Family jewels

Although taxation is a key feature of estate planning, it should never be the predominant one. All private client advisers will be familiar with trusts and their use as a protector of assets. The separation of legal and beneficial ownership in such a manner is often a singular powerful reason to undertake such planning.

Securing wealth preservation in a manner that the donor sees fit can arguably only be achieved via a trust. Furthermore, despite the restrictions that the tax legislation may now impose upon trusts, it is perhaps the only planning option for which a settlor can benefit individuals who have not yet been born. 

For years the family trust was the go-to vehicle when it came to sheltering assets from exposure to inheritance tax (IHT). It was a tried and trusted method that allowed individuals to give away assets while continuing to exercise a level of control over them – often a crucial requirement where beneficiaries were either children or young adults and immediate access to large funds would be undesirable.

Declining popularity?

It is often cited that trusts have declined in popularity. There is undoubtedly a barrier to settling assets on trusts since the 2006 reforms. The 10-year IHT charge was brought in by Gordon Brown during his time as chancellor, and his successors continued this punitive approach towards trusts.

Put simply, the £325,000 nil-rate band limit (doubled for spouses jointly settling assets) is not always sufficient to meet the long-term IHT planning aims of high-net-worth clients, especially if they wish to make greater inroads on potentially mitigating future exposure. Of course, the trust route still works extremely well in circumstances where business property relief or agricultural property relief can enhance the value of the assets settled on trust. This is one area in which trusts certainly maintain an advantage over the family investment company (FIC). 

The other off-putting element of trusts is the increased compliance burden imposed via the Trust Registration Service (TRS). While this should be a straightforward process, HMRC has failed to implement the TRS smoothly and online access remains challenging. 

The rise of the FIC?

On the other hand, the tax position for companies has remained relatively favourable. Corporation tax (CT) rates have plummeted to record lows as the government has sought to attract business to the UK by creating a competitive corporate tax system. 

This has opened a new window of opportunity in terms of IHT planning. A company could provide the flexibility and retention of control over assets needed while avoiding some of the tax costs and red tape associated with trusts.

Clients holding surplus capital (usually more than £2m in light of the level of compliance costs and the IHT exemptions available on death) are increasingly turning to an alternative IHT planning route. It is an attractive proposition for many clients. There is still a general desire to maintain control, which can be afforded via directorships and well-crafted articles / share rights, but even these approaches will never fully replicate the bespoke nature of trust arrangements. FICs nowadays seem to come hand-in-hand with complex considerations as to how the shares can be retained by the family, especially in potential divorce scenarios.  

Our experience has tended to show that certain clients may prefer a company if they’ve run their own businesses. It is widely recognised that FICs can remain discreet by using an unlimited company and removing the ultimate requirement to file accounts at Companies House (although the timeframe for establishing these at Companies House is slightly longer and full accounts are still likely to be prepared for the purposes of the CT return). In comparison to the compliance requirements of a trust, this may be somewhat more onerous. 

What is the planning angle?

It goes without saying that all planning structures should be tailored to the needs of the family and situation.

The choice between a FIC or trust largely revolves around estate planning for IHT purposes. The FIC route will be preferable if the clients wish to retain their capital or income. A settlor cannot retain any benefit if they wish to establish a trust and preserve the taxation advantages. 

The best way to compare these differences is by considering the funding of both entities. As mentioned above, the level of capital that can be settled on trust is capped at the nil-rate band (amounts above £325,000 give rise to an immediate IHT liability).

There are multiple options in relation to the funding of FICs, however care should still be taken to ensure the approach does not result in making a potential gift with reservation of benefit rules or falling foul of the settlements legislation; this is despite HMRC having closed its specialist unit and review last summer.  

The company can be established with different classes of shares with a view to giving away capital appreciation. Parents or grandparents can make cash gifts to children / grandchildren who in turn subscribe for new shares on incorporation. Clearly, such work will require the input of a corporate specialist. The alternative and very useful approach is to consider funding the company by way of a loan. This provides a ‘loan account’ from which the lender can continue to make drawdowns or consider assigning the benefit over time, perhaps even to a family trust. The hybrid approach of using a trust in conjunction with a FIC can be very attractive. This structure permits beneficial ownership and investment growth to be secured for minors.  

FICs also offer the prospect of share discounting when valuations are required, for example on death. This may be particularly powerful when the FIC includes residential or commercial property.

Finally, an added and unique advantage of the FIC is that the companies can receive dividend income tax-free, meaning that more investment returns can be retained. The company structure can permit distribution of income to shareholders in a flexible manner but care will need to be taken. The tax-free allowances available to younger shareholders – who may have little or no other taxable income – can still potentially be used to achieve tax-efficient distributions (in a similar manner to a trust). In some instances, this income tax advantage is the potential driver for considering a FIC. 

How about property FICs?

The rise in the popularity of the FIC is also in part owed to the trend towards incorporation of property portfolios. For example, FICs can be used to manage wealth preservation of buy-let-property assets. 

The landmark decision in Ramsay v HMRC [2013] UKUT 0226 (TCC) paved the way for many landlords to set up limited companies where capital gains tax (CGT) had previously been a stumbling block. 

The case saw the Upper Tax Tribunal allow a taxpayer to claim incorporation relief for CGT upon the transfer of their property portfolio. This enabled the taxpayer to roll over capital gains arising on transfer into the cost of their shares in the new company, extinguishing an immediate CGT liability. 

HMRC policy had previously been to disallow such claims for property companies. 

Without this relief the CGT cost could be quite significant – particularly for those who have owned their property portfolio for many years and have seen house prices skyrocket. 

Given that the landlord would typically receive no cash consideration from their company, they would need to find the funds to settle the tax bill from their personal finances. 

Unsurprisingly, this had deterred landlords away from the limited company route, but with the CGT problem now seemingly removed, incorporation became a much more attractive prospect.

There remains the issue of a charge to stamp duty land tax, however this can be mitigated if the appropriate steps are taken in the planning phase. 

With the backdrop of decreasing CT rates and the later introduction of restrictions to loan interest relief for individuals, the tax benefits of letting through a company became ever greater. 

The future of the FIC – a flattening of the curve?

But the roadmap ahead may start to alter for the FIC, especially in light of recent tax changes sparked by the coronavirus (COVID-19) pandemic. The pandemic saw spending reach record levels and there was much speculation as to how the government would look to fill the black hole in the country’s finances. 

In his autumn budget speech in 2021, chancellor Rishi Sunak revealed that it would be businesses that would bear the brunt of the increased tax costs. He announced that CT would rise to 25%, breaking away from the previous policy of a drive toward lower taxes for companies.

The government had previously passionately defended this policy of driving down CT even in the face of criticism, arguing that it made the UK a more attractive prospect for businesses overseas and would benefit the British economy in the long run. CT rates as low as 17% were even mooted at one point.

But something had to give, and the U-turn will see the CT rate rise for the first time in several decades with effect from April 2023. Sunak did say that only the biggest businesses would pay more – introducing a sliding scale of rates ranging from 19% to 25% based on profits. But what became apparent upon the release of further details was that FICs would be subject to the top rate of CT regardless of their size.

According to HMRC’s definition, most FICs will be “close investment holding companies” which are subject to the 25% rate, whatever their profit level. With dividend tax on distributions also going up, many FICs will see the tax advantages they were set up to achieve possibly scaled back. While the long-term IHT planning benefits of the FIC remain, the erosion of the shorter-term benefits of lower tax on profits is likely to impact its overall popularity, in particular given the many costs and filing obligations that come with company ownership.

Conclusion

The FIC does now have a firm place in the IHT planning arena, but perhaps recent government policy will see a slight shifting towards new planning structures. There are many direct comparisons between FICs and trusts, but they should not be considered as two distinct options – savvy advisers should consider the use of both entities in combination. A hybrid structure can permit the long-term benefits of wealth preservation via shares held within the trust and can potentially enable the structure to continue over multiple generations.