Passing on your wealth to the next generation - the pros and cons of family investment companies
Trusts are traditionally the way in which families pass down wealth to future generations.
However since the changes brought in by the 2006 Finance Act, there have been big disincentives for those wishing to put more than £325,000 (value of the nil rate band) into trust. Investments above this level will now attract a 20% inheritance tax charge.
A tax efficient alternative to trusts
Family Investment Companies (FIC) are now emerging as a feasible alternative for those who are wanting to pass their wealth on in a tax efficient way.
An FIC is a private company where all the shareholders are members of the same family. The FIC will have articles of association, and these can be drafted to suit the needs of the family.
For example, they can be drafted to allow the donor to retain some control over the company. The articles of association and memorandum are public documents. You could consider a Shareholders’ Agreement for more sensitive terms as this can be kept private.
What are the advantages?
Corporation tax savings
The donor usually funds the FIC with a loan which can be repaid from profits free of tax. Other family members are the shareholders and often different classes of shares are created to meet the needs of different family members. Profits (once any loan is repaid) are taxed at corporation tax rates (20%). These are set to be reduced to 17% in 2020.
Inheritance tax savings
When shares are gifted they are treated as a potentially exempt transfer and so there is no immediate charge to inheritance tax. As long as the donor survives seven years, they will fall out of their estate for inheritance tax purposes.
Income tax savings
There are no restrictions on the class of assets in which the FIC can invest. Dividends on equities can be received by the FIC free of tax. Income usually paid in the form of dividends, can roll up tax free inside the company, as no income tax is payable until income is paid out. The new tax rules mean that the first £5,000 is free of tax.
Practical incentives
FICs can be a very good way to pay university fees and living expenses for student offspring. Whilst the income of minor children is taxed at the parents’ rate, children over 18 can receive income up to the personal allowance without paying tax.
FICs and divorce
In the event of a divorce the ‘corporate veil’ will not be pierced, meaning that if a divorcing spouse asks the court to transfer funds to them from the FIC, the court may refuse to do so.
What are the disadvantages?
If non-cash assets are transferred into an FIC then capital gains tax and stamp duty land tax will be payable. And when assets are transferred out of the FIC there will be income tax to pay, effectively meaning that there is double taxation.
It is of course very important to take advice before setting up an FIC. However for the right family they can be a tax efficient choice.