Posted by James Pearson on 14 May 2020
Family Investment Companies
Companies are increasingly being used as a vehicle for family investments due to a low rate of tax (Corporation Tax is currently payable at just 19%) and the ability to use shares and directorship roles to keep control with certain family members, while allowing the whole family to benefit from income and capital growth.
What is a Family Investment Company?
A Family Investment Company (FIC) is an ordinary limited company, with shares held by different members of a family. Typically, each family members would hold a different class of shares with targeted share rights giving them specific rights to income, capital and to vote at company meetings.
In a FIC, the ‘parent’ investors will have shares of a class with voting rights only, and no right to the company capital, whilst the ‘descendant’ shareholders will hold shares which may have no rights to vote, but will have rights to all the capital value of the company.
The FIC investments can be funded by loans (often from the ‘parent’ investors). As the loan does not transfer net value into the company (the assets loaned to the company are equal to the company’s debt to the lender), this does not affect the capital value of the company.
The company can then use the funds to make investments increasing the company’s assets. This growth in value only increases the value of the shares with capital rights, whilst the income and gains in the company can be used to repay the loans from the investor without additional tax being due.
Loans are relatively easy to move, meaning that the investors who made loans to the company, can transfer those loans to other family members, without triggering an income tax or capital gains tax liability. The company could then repay the loans to other family members.
What are the Tax Benefits?
A FIC transfers the future growth of an asset from the ‘parent’ to the ‘descendants’, without any transfer of value that would be subject to Inheritance Tax (IHT). The FIC achieves this while allowing the ‘parent’ to maintain control over the investments.
Where cash is lent to the FIC, no tax is payable on the formation; UK corporation tax is payable on the profits and gains of the company (currently 19%), and the remaining profits can be extracted through repayment of the loans with no further tax charge. This is a significant saving over the income tax rates payable by individuals at up to 45% and capital gains tax at up to 28%.
Although the asset itself remains in the investor’s IHT estate, by using an FIC, the future growth is protected from IHT while the investor is able to retain control over their assets and to access the income and gains arising on the assets in a tax-efficient way in order to fund their lifestyle.
How Can a Family Investment Company be Used?
While most investments benefit from the 19% rate of corporation tax when owned by a FIC, certain investments are even more tax efficient.
A FIC will not pay tax on dividends that it receives, meaning that a FIC is well suited to holding share portfolios as the full amount of dividends received can be reinvested, or will be available to repay any loans.
Individuals who own properties are subject to a restriction on their tax deduction for mortgage interest on rental properties. Companies are not affected by this restriction meaning property is an especially good FIC investment for properties that are to be highly geared.
What are the Potential Pitfalls of a Family Investment Company?
As with all companies, tax could be payable under the benefit in kind rules if any individual benefits from the company, other than as salary or dividends (which are taxable under different rules). This means that tax would be due, undermining any tax saving within the FIC, if properties or other FIC assets are used by people connected with that company. Additionally, the FIC would be subject to the ATED tax charge if properties it owns are not let to unconnected third parties.
The tax benefits of a FIC are based on the current low rates of corporation tax, so these benefits may be reduced if corporation tax rates rise. If changes to tax legislation remove the benefits of the FIC, the structure could be unwound through repayment of any outstanding loans and liquidation of the company. Liquidation would trigger corporation tax on any capital growth within the FIC and assets could be paid out to shareholders at a 20% rate of tax.
If you want more information on family investment companies, or any other areas of tax, please contact us by email or telephone today.
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