2020-08-18
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HMRC scrutiny of family investment companies

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Posted by Eamonn Daly on 06 July 2020

Eamonn Daly - Tax Adviser
Eamonn Daly Partner

A short introduction to FICs

A family investment company (FIC) is a tax-efficient vehicle allowing protection of, and control over, wealth transferred out of an individual’s estate.

Shares in the FIC, or assets to subscribe for them, are given to family members without an inheritance tax (IHT) charge as long as the donor survives for 7 years.  FICs are companies and thus their profits are taxed at corporation tax rates. Companies do not pay tax on dividends received from most other companies. Non-dividend income and gains are taxed currently at 19% (although it is conceivable that this rate may rise given the need to balance the books once the current pandemic has passed).  When the income is eventually paid out from the FIC as a dividend, individual shareholders’ usual tax rates will apply.

HMRC establishes FIC Unit

Following a freedom of information request from a public relations firm working for Pinsent Masons, it transpired that HMRC had set up a Family Investment Companies (FIC) Unit in April 2019. The unit is tasked with conducting risk reviews of private companies used by family offices and high net worth individuals to manage their wealth and making sure that they are operating in line with UK tax laws.

According to the PR firm, HMRC is also likely to examine how FICs could be used as a means for ultra-high net worth individuals to move assets offshore, for example by transferring assets to another company incorporated in a lower tax jurisdiction overseas.

Some of the wider reporting stemming from the revelation talked about an HMRC ‘secret unit’ targeting loopholes and avoidance. However, given the increased popularity of FICs, HMRC clearly needs to understand them and how they work. As well as looking at the possibility of moving assets offshore any review of the tax treatment could cover a number of other areas.

Inheritance tax

We have always taken the view that creating a FIC is about protecting wealth from the injudicious actions of family members rather than illegitimate tax avoidance. There is the same tax consequence on the gift involved in creating a FIC as there would be if the gift were of the underlying funds. A FIC therefore remains firmly in line with UK tax law rather than an attempt to exploit any loopholes.

In January, the All-Party Parliamentary Group for Inheritance & Intergenerational Fairness made a number of wide-ranging recommendations designed to simplify IHT which has been criticised for becoming progressively more complicated. One suggestion was to tax lifetime gifts above a £30,000 annual allowance. If implemented, such a change could discourage large lifetime gifts generally, including setting up FICs. In contrast, an Office of Tax Simplification report last summer suggested that the need to survive for 7 years from the date of a gift to escape IHT could be reduced to 5 years, although coupled with abolition of other exemptions and reliefs.

The value of FIC shares held by shareholders will be discounted for IHT purposes from the proportion of the value of the total assets in the FIC that they represent because they are usually a minority interest in the company and have restrictions on them. It might be that HMRC could seek to diminish this ‘second generation’ IHT saving by reducing the minority discount that applies in these circumstances.

Reform of IHT may not at the moment have the same priority for the Government as other areas which bring in more tax but is certainly one to watch in future.  

Tax on income and gains

The normal company tax rules applying to a FIC have been increasingly beneficial as the gap between corporation tax and personal tax rates has widened. Before dividends are paid from a FIC, there is a deferral of income tax over the position where the assets are held personally or in a trust.

FICs are rarely established as trading entities and usually only involve members of the same family, so FICs generally fall into the bracket of closely held investment companies. Historically, such companies paid the highest rate of corporation tax on profits. This was still less than the highest income tax rate for individuals so the tax deferral until income is distributed as a dividend, even for investment companies, is not new.

This benefit offsets the disadvantage of not being able to distribute the capital of the FIC easily without possible double tax charges and may be seen as an acceptable trade-off. If, however, a higher corporation tax rate for investment companies was re-introduced or shareholders were taxed on undistributed FIC profits, the advantage would be reduced.

The income tax deferral via a FIC is in any case just a bonus of using a corporate structure. The reason why FICs were developed was rather to enable potential IHT savings through making protected gifts. 

If the total tax rate on distributed FIC profits were not significantly more than the top income tax rate for individuals and trusts, the incidental benefit may be reduced but the main focus of FICs as an estate planning vehicle would remain.

Loan capital

HMRC could target thinly-capitalised FICs where much of the initial value is represented by loan capital. The loan capital could be, for example, direct loans to the FIC and/or shares held which are redeemable at their initial subscription cost.

Loan capital provided by the founder could be particularly at risk where it is interest-free or on otherwise non-commercial terms. This could be seen by HMRC as an avoidance tactic as repayments would not be subject to either income tax or capital gains tax, albeit that they are limited to the amount of the capital funded in this way.

Highly-geared funding of companies has been recognised as a potential issue for some years as thinly-capitalised companies have been targeted by HMRC in other areas of tax. We have accordingly long suggested a limit on the proportion of loan capital in FICs.

Conclusion

A FIC is a straightforward company structure and the usual tax rules applying do bring tax advantages. This leads some to view FICs as a tax avoidance vehicle. However, in our experience, a FIC is at its most useful when seen as a long-term solution to the thorny issue of protecting a family’s wealth, rather than a short-term method of maximising assets by minimising taxes. Despite debate over different methods of set-up and structure and HMRC scrutiny, FICs do still provide a practical way of protecting family wealth via the separation of value and control.

In the knowledge that HMRC are looking at FICs, it is crucial that the company documentation is drafted carefully to suit the particular family situation and founder’s objectives. In other words, if it has all the hallmarks of a genuine, long-term solution to protect the family’s wealth against misfortune and misappropriation without seeking to exploit the tax benefits of a corporate structure artificially, then it is less likely to fall foul of current or future anti-avoidance provisions. 

About the author

Eamonn specialises in tax, estate planning and trust advice for individuals and families.

Eamonn Daly

Eamonn specialises in tax, estate planning and trust advice for individuals and families.

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