How do you pass on your wealth to the next generation tax efficiently, whilst ensuring that they don’t just spend it all at once?! This is a question often posed by clients considering succession planning.
For many years, the answer has been to transfer assets into trust for the benefit of the next generation. However, with the trust regime in the UK becoming less favourable, families are looking for alternative approaches. The Family Investment Company (FIC) is able to offer parents the benefits of retaining an element of control over assets, whilst offering families greater flexibility to adopt a structure that suits their needs. Furthermore, the family investment company has a proven track record – put simply, it works! So, what’s the structure?
1. In its simplest form, a new company is formed, with Mum and Dad subscribing for, say, 50 shares each. Mum and Dad also appoint themselves directors of the company to retain control over the company management.
2. Mum and Dad then transfer their rental property portfolio to the company in return for a loan account equal to the market value of the assets transferred.
3. At this point, the assets and liabilities of the company are equal and the company therefore has no value. Mum and Dad immediately decide to each transfer 50 shares to their son and daughter. As the shares have no value at the time of transfer, there are no inheritance tax or capital gains tax consequences arising on the gift.
4. However, Mum and Dad may wish to retain shares in the company. In this instance, an alternative share structure may be adopted to incorporate voting and non-voting rights, or ordinary and preference shares, depending on the family dynamics. The value of any shares retained by Mum and Dad will be subject to inheritance tax if they are still held at the time of death.
5. The company will be subject to corporation tax at 19% on its taxable income (compare this to 45% income tax in a discretionary trust). The annual post-tax profits can then be utilised to repay the loan owed to Mum and Dad. Assuming repayment is made on an interest free basis, the loan repayment will be received without income tax consequence.
6. As the company’s liability (to the bank of Mum and Dad) reduces, and the value of the company assets increases, the value of the shares will too increase. The growth in value will be outside of Mum and Dad’s estate as they no longer own the company shares.
7. Mum and Dad will be liable to inheritance tax on the balance of the loan account outstanding at the time of their death. However, assuming that the debt is repaid in full during their lifetime, the profits can be retained in the company or can be distributed to shareholders.
Sounds too simple, “what’s the catch” I hear you say? The transfer of property into the company may give rise to a capital gains tax charge and stamp duty land tax may also be payable, calculated with reference to the property’s market value at the time of transfer. There are reliefs available which may help clients to mitigate their exposure to tax on incorporation.
Ultimately, whether a FIC is the right structure for you and your family business will depend on your individual circumstances. The tax implications vary and professional advice should be sought before embarking on this path. However, when implemented correctly, the structure can provide families with an alternative to the traditional trust as a key part of wealth planning.