For most of my clients, when it comes to securing their wealth for their children, grandchildren and beyond, and reducing their liability to Inheritance Tax (IHT) on their deaths, their first thought is a family trust. Trusts can work extremely well in the right circumstances, but for many clients the right solution may be more corporate.

2006 – not a good year for trusts

After Finance Act 2006 was enacted, it became very difficult to transfer assets into trust without incurring a charge to IHT. The Act also brought most trusts within the IHT regime that imposes charges every ten years on the whole value of the trust, and whenever assets are distributed to beneficiaries.

It’s also worth noting that, whilst inflation has averaged 2.9% - 3.0% per year for the last 10 years, the value that can be put into trust without creating an immediate 20% charge to Inheritance Tax has remained virtually the same: £325,000 for an individual or £650,000 for a couple.

If my clients, a married couple, wish to transfer say £1m into trust i.e. enough to generate enough income to pay school fees for their grandchildren, and to help with future property purchases, they would be looking at an immediate Inheritance Tax bill of £70,000. This is assuming they settle a trust jointly and both have their full nil rate bands available.

In addition, clients often feel uncomfortable relinquishing control of assets they have built up over many years of hard work to third party trustees. For my entrepreneurial clients in particular, this loss of control can be an issue.

Also, crucially, it is almost always necessary to completely exclude the settlor(s) of a trust and their spouse or civil partner from ever being able to benefit from the trust. If the settlor (or the spouse or civil partner) does retain use of, or benefit from, those assets, the tax benefits that a trust can bring will be lost. Many of my clients are wealthy enough to be considering estate planning, but not quite wealthy enough yet that they can say goodbye forever to a large chunk of assets.

So what is the alternative, if a trust isn’t the right choice?

Setting up a FIC

Whilst I take my hat off to the clever person who thought to rebrand a well-established idea with a new and snazzy title, a FIC is, quite simply, a private company owned by shareholders who are family members. FICs are not - in their purest form - a new or innovative idea (Dains advises a FIC that has been incorporated since the 1930s!), although there are as many variations of structure, ownership and assets as there are families who want one.

The art, as with most things we do in the world of Personal Tax, is in listening - understanding your client’s objectives, their unique family make-up, their worries and concerns - and then designing a FIC structure that works for them.

Normally, a limited company will be used. Unlimited companies can be used instead, to preserve privacy, as unlimited companies do not need to file publicly available accounts with Companies House. However, advice and care are needed as unlimited companies do not offer protection from personal liability of the shareholders for the company’s losses. In addition, unlimited companies are not suitable for FICs intending to carry on certain activities, for example consulting contracts with public sector bodies.

The company is virtually always incorporated with several different classes of shares to enable flexibility over the payment of dividends. Shares can be subscribed for by, or immediately gifted to, different family members. We often advise the use of a family trust as a shareholder to hold shares for younger family members, or those not born yet, or even adult children with questionable spouses or colourful personal and financial histories!

We almost always advise our clients to consider using “growth shares” i.e. shares that have the rights to all future growth in the value of the FIC. The growth shares would be held by adult children and/or a trust, to reduce the IHT exposure of the clients setting up the structure.

The clients creating the FIC can subscribe for shares that have built into them all the voting rights in the company. They can also be the directors, so that they can retain complete control over the activities and management of the FIC and the payments of any dividends or salaries.

They can loan cash or assets into the FIC, and if they do require access to funds, this can be achieved via tax-free loan repayments, rather than taxable dividends or salaries. We have advised on a huge array of non-cash assets being transferred into FICs, from properties to shares and even – once – a racehorse.

The key tax benefits of using a FIC:

• Non-dividend income earned in the FIC is subject to Corporation Tax at 19% (reducing to 17% from 2020/21), as opposed to being taxed personally at up to 45%.
• UK and most non-UK dividends received by the FIC are exempt from tax, as opposed to being taxed at up to 38.1% personally.
• Any capital gains in the FIC are also subject to Corporation Tax, as opposed to Capital Gains Tax at up to 28% (for residential property disposals). In addition, companies still benefit from an inflationary relief that reduces taxable capital gains, whereas individuals do not.
• In relation to IHT, the future growth in the value of the assets transferred into the FIC will be immediately outside of the taxable estates of the clients setting up the FIC, saving IHT at 40% on that growth. If shares are gifted by them to their children etc, then the value of those gifts will be outside their estates provided they survive seven years.
• Dividends and salaries can be paid to the various shareholders to make use of their available personal allowances and basic rate bands.

Points to consider:

• We normally advise that to be cost and tax efficient, at least £1m-£2m is transferred into the FIC initially.
• If non-cash assets, such as share portfolios, are transferred into the FIC, care is needed as this may trigger CGT. If assets have recently been inherited this can be a great time to transfer them into a FIC as they will have benefitted from an uplift in base cost, minimising any CGT on transfer.
• We always advise that if shares are to be given to children, grandchildren or a trust, this is done on the creation of the FIC and before it holds any assets. This is because if shares are gifted later, they may have significant value and this could again trigger CGT. It also removes any IHT risk around the donor not surviving seven years.
• A FIC is most efficient when most of the income generated in it can be left within the company for reinvestment and is not immediately required by the family. Any income paid out as dividends will have already suffered Corporation Tax. If most or all the income is paid out, this “double charge” could result in a higher effective tax rate than would have been suffered if the assets were still held personally.
• The initial value of any cash or assets lent to the FIC will always be within the IHT estates of the clients creating the FIC. It is the growth on those assets that can be successfully removed from their estates. Of course they may later decide to gift the loans away, but advice should be taken on this as HMRC may view this as contrived.
• If the shareholders die, their shares in the FIC will be subject to IHT. However, if they hold less than 50% of the FIC’s shares, the value will be heavily discounted as a “minority shareholding”. Similarly, if a shareholder gets divorced, the minority discounts should reduce the value taken into account in proceedings.
• There will be initial set-up costs and advice costs, as well as ongoing running costs.

Asset protection

This is a tricky subject but is often a very important consideration for my clients. Many of them wish to protect their family’s wealth from future divorces of their children or grandchildren. Trusts can offer this if tightly worded and properly drafted, but a number of cases heard in recent years have weakened this security.

In relation to FICs, the Supreme Court decision in Prest v Petrodel [2013] is helpful. The judgement was that the family courts cannot “pierce the corporate veil”, i.e. look through a company that a party to the divorce holds share in, to seize its assets in a settlement.

The shares themselves can be part of a divorce settlement, but the Articles of Association and Shareholders’ Agreement of the FIC can be structured to restrict any transfers or ownership of shares to any non-family members and/or spouses.

As mentioned above, keeping any shareholdings held directly by children or grandchildren should help reduce any value taken into account in divorce proceedings.

Taking FICs further

Landlords and property investment

Highly topical now is the phasing out of higher rate relief on mortgage interest for private landlords. We are now into the second year of the phase out period, and higher or additional rate taxpayer landlords are feeling the pinch. Those looking to invest in rental property may prefer to do so via a company, which they can set up as a FIC to benefit their families long-term.

There are many things to consider here, such as the attitude of lenders to lending to companies rather than individuals, Stamp Duty Land Tax, and the Annual Tax on Enveloped Dwellings. However, it can work very well and Dains can advise in more detail on this if required.

As well as those just embarking on property investment, or those wishing to acquire several new properties, I also have many clients who already hold several investment properties, and who assume that the charges to CGT and Stamp Duty Land Tax preclude them from moving those properties into a company. This is not always the case. It is worth taking specialist tax advice in these scenarios, as the long-term tax and succession benefits that can be achieved can be surprising.

Money-lending companies

FICs can also be used as money-lending companies, so that the activities of the FIC constitute a “business” for IHT purposes. If correctly operated, and subject to future changes in case law, the shares in the FIC can potentially qualify for Business Property Relief, meaning they could be completely exempt from Inheritance Tax on the death of the shareholder. Expert tax and legal advice is required here as this is a highly specialist area.

Removing excess cash from trading companies

Where a trading business has been successful and has built up cash reserves that are now jeopardising Entrepreneur’s Relief and Business Property Relief, it is possible to restructure so that a FIC holds shares in the trading company that entitle it to dividends of excess cash. Dividends can then be paid up to fund the FIC, and the FIC operates as has already been set out above. This is a great way to maximise reliefs for the owners of the trading company and enabling immediate funding for a FIC without the owners needing to fund it personally.

“FIC before a sale” planning

Finally, I am advising right now on what I have catchily termed a “FIC before a sale”. This particular structure is a new trading business created with a FIC as a 49% shareholder. The FIC is owned by my clients and a family trust. We have created the whole structure from scratch, and the idea is that in 5-10 years’ time the trading business will be sold for several million pounds.

Utilising the recent relaxation to the Substantial Shareholdings Exemption - i.e. that the selling company no longer needs to be a trading company immediately after the sale - should mean that the gain will be tax-free in our FIC, and we then have a fully-funded FIC ready to start building up wealth for the family. Even before the sale, we can pay up dividends through to the trust at the top, to pay grandchildren’s school fees.

Conclusion

FICs are something many people talk about in the tax world, but surprisingly few advisers have actually set one up. As a firm that has set up many FICs, we are seeing huge momentum and interest from clients and intermediaries, especially when we sit down with them and explain just how flexible and personal they can be for the family.

If you are a client, or adviser of a client, with a client with a significant sum of cash or other assets and would like to discuss how we could assist with setting up a FIC, we would be delighted to discuss further with you.

Ellie Lewis
elewis@dains.com
t: 0121 200 7936
m: 07889 721140

Tags: UK200

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