What to do with your spare cash
The popular strategy of putting spare cash into a trust for the family, to avoid inheritance tax, is no longer as attractive since the rules changed back in 2006. It’s a good way to manage family funds, but it has few advantages from a tax point of view.
For high net worth individuals with a considerable estate, creating a Family Investment Company (FIC)could be a very effective tax planning vehicle. A FIC is a private investment company, which is mainly used for family succession planning. The company’s directors and shareholders are individual family members/trusts.
The FIC will be registered at Companies House. It usually has limited liability powers regarding the appointment of directors etc. granted solely to the founders, to enable them to keep control of family wealth and finances.
How it works
Effectively the FIC is structured so that the primary investor has a few A class shares he/she owns, with voting rights, but no dividends. B class shares, with no voting rights, are gifted to family members that the primary investor wants to benefit, as these shares do receive dividends. Providing the shares have been gifted prior to the FIC’s value increasing, they are not subject to Capital Gains Tax.
As long as the primary investor survives for seven years after setting up the FIC, the funds are not subject to Inheritance Tax as they have been removed from the estate.
The company doesn’t trade, but operates purely as an investment vehicle. As the primary director, the owner may buy property, invest in shares, or place available funds in high interest bank accounts, etc. It will pay tax on profits and capital gains on the sale of assets and the beneficiaries will pay tax on any dividends paid to them, but it gets capital value out of the estate and provides an income to individual members of the family.
It can be easy to discount this as something only for very wealthy people and, for sure, the money put into a FIC can’t be taken out again. However, when elderly parents pass on it’s not unusual for a property they bought 50 years ago for £20K to now be worth £1-2 million. If their children are already established the property is sold and there’s a substantial inheritance. If the family doesn’t need that lump sum, creating a FIC will provide an ongoing income for the family members further down the road.
The tax implications
- The corporation tax rate will normally be 25%. Bank charges and interest can normally be deducted.
- Dividends received by the FIC will be exempt from corporation tax.
- Capital gains made by the company will be liable to corporation tax at 25%. In some cases it may be possible to claim the substantial shareholdings exemption. Broadly, the FIC must hold at least 10% of the shares in the subsidiary company and the company being sold must be a trading company.
- Management expenses: when the FIC incurs expenses to manage its investments and to run its business, these will be eligible for relief for corporation tax. Examples would include investment manager’s fees and remuneration paid to employees or directors.
The benefits
- While you no longer ‘own’ the funds you invest in an FIC, you still have control of them.
- It gives a regular income in the form of dividends to your chosen beneficiaries.
- It costs less to set up and operate than a trust.
- It protects the kids’ funds from avaricious spouses.
However, when you die you have to will your A class shares and control to someone else, so that needs to be someone who will continue to keep the FIC in good shape.
