A family investment company (FIC) is a long-term tax efficient vehicle that enables an individual to pass assets out of their estate for inheritance tax (IHT) purposes while retaining control and protecting them.
For many people a trust is the most flexible way to achieve this, as the lifetime IHT threshold of £325,000 per individual will sufficiently mitigate their potential tax liabilities. However, assets worth more transferred to a trust would be subject to an immediate 20% IHT charge.
This is where FICs come into their own enabling a transfer of value above the IHT threshold out of an individual’s estate without relinquishing control or the immediate tax charge.
How do I set up a FIC?
Firstly, company memorandum and articles of association, tailored to the specific family requirements, are drafted for the FIC.
The donor then typically transfers cash so that it is held for their beneficiaries and then used to subscribe for different classes of ordinary shares in the FIC immediately. At the same time, the beneficiaries enter into a shareholders’ agreement, which is a private document setting out the directors’ powers and shareholders’ rights.
The beneficiaries can also subscribe for other types of shares with differing rights including tax efficient withdrawal of capital, enjoyment of growth in capital value or a right to future dividends. (The donor could also subscribe for shares but with safeguards to prevent them benefiting from other capital in the FIC, otherwise the IHT advantages would be undone).
How do I exercise control over the FIC?
The shareholders’ agreement coupled with the company articles provide that control will rest with the board of directors usually comprising the donor and spouse or other trusted individuals.
The board will have power to appoint other directors and to make decisions such as how the cash held is invested, distribution of profits, and whether shareholders may transfer shares. The power to appoint directors can pass to individuals/trustees of the donor’s choosing following death.
Importantly the donor has these powers as a director without the need to hold voting shares in the FIC which themselves would have substantial value chargeable to IHT.
How else is family wealth in the FIC protected?
Whilst the underlying assets of a FIC are generally beyond the reach of the court or creditors in the event of a divorce or bankruptcy, the value of a shareholder’s holding can be taken into account when determining the total value of their assets.
The terms of the company articles will prevent a transfer of shares, other than to certain individuals/trusts, and the value of the shares will be further substantially reduced by the restrictions in the articles and shareholders’ agreement. The requirement for shareholders to enter into pre- and post-nuptial agreements could also be built into the shareholders’ agreement.
Creating a tax efficient legacy
Transfer to the shareholders
A transfer of cash to individuals to subscribe for shares will be outside the donor’s estate for IHT purposes providing they survive for seven years from the date of the gift, with some taper relief for the value of gifts above the IHT threshold after three years. It will not be an immediately chargeable transfer and so will avoid the 20% IHT charge.
Often the donor will also gift cash to a trust, of which they can be a trustee, to subscribe for shares in the FIC and give even greater control and flexibility over these shares. As long as the amount gifted to the trust is within the donor’s available IHT threshold, there would be no tax due on the transfer.
Any gains showing on non-cash assets gifted by the donor to the shareholders would crystallise and potentially incur a capital gains tax (CGT) liability at rates of up to 28%.
Creation of the FIC
There are no tax implications if cash is used to subscribe for the FIC shares, but the FIC would incur stamp duty or stamp duty land tax if assets such as company shares or property were used.
If any gains were showing on non-cash assets used to subscribe for FIC shares, they would crystallise and potentially incur CGT, similarly as on a gift of assets by the donor.
During the lifetime of a FIC
Any increase in the value of the shares subscribed for by the other shareholders would not be part of the donor’s estate for IHT purposes.
Most dividend income received from other company shares held in a FIC is not subject to corporation tax. Non-dividend income received within the FIC is charged at the 19% corporation tax rate (reducing to 17% from April 2020). Gains made within the FIC (after claiming indexation relief, which is not available for individuals) are also charged at corporation tax rates.
These tax rates on income and gains accumulated within the FIC compare very favourably with those applicable to individuals and trusts.
For shareholders extracting profits via dividend payments there is an annual dividend allowance of £5,000 (£2,000 from April 2018) available to all taxpayers, irrespective of the level of income they receive. Dividend income above this allowance is taxed at 7.5% on income up to the basic rate limit, 32.5% between the basic rate limit and the higher rate limit and 38.1% above.
The directors will have power to declare different dividends on different classes of shares enabling distributions to be made tax efficiently.
There would be an element of double taxation on non-dividend income received and distributed from the FIC rather than accumulated within it; this income is subject to corporation tax and shareholders would be liable for income tax on the amounts they receive.
Very often shareholders will subscribe for redeemable preference shares. These can subsequently be redeemed at the option of the directors so the shareholders can receive a limited amount of capital from the FIC without tax consequences.