Insights

Trusts have been in the spotlight for some time and their tax saving advantages for the majority of taxpayers are declining; most recently, we highlighted new restrictions in the use of pilot trusts for inheritance tax planning. As a result of the dwindling benefits and increasing costs of trusts, it’s useful to identify alternatives for those seeking tax efficient alternatives for sharing and growing their wealth within the family, and passing it down to future generations.

The amount that can be settled on trust is effectively limited because transfers in excess of the donor’s nil rate band of £325,000 attract inheritance tax at the lifetime rate of 20% unless they qualify for other inheritance tax reliefs, such as Business Property Relief; and whilst assets held on trust are outside of anyone’s estate for inheritance purposes, they do not avoid inheritance tax altogether because they attract 10 yearly IHT charges and exit charges if the assets are taken out of trust at a later date.

A Family Investment Company is an ordinary limited liability company whose shareholders are the family members; any amount of cash can be transferred into the company tax-free and from 6^th April 2015, the rate of corporation tax is 20%, irrespective of the size of the company.

If other assets are transferred into the company, such as rental property, shares or other investment funds, these are likely to give rise to a capital gains tax liability and therefore advice should be taken in advance of the transfer.

A Family Investment Company can be used as long term investment vehicles in which profits generated over a financial year will be taxed at the lower corporation tax rate (20%) as opposed to the applicable personal tax rate (up to 45%). Using a company wrapper is also a good way of retaining control over the assets because the beneficiaries are shareholders whose rights can be restricted, and control can be retained over decisions relating to the distribution of income.

The shares in a Family Investment Company will attract inheritance tax on death, and are unlikely to qualify for business property relief, because they will be investment, rather than trading companies. For capital gains tax purposes, the beneficiaries inherit their shares at their market value on the date of death of the donor.

How do Family Investment Companies work? Consider the following example

The Brown family has considerable cash savings; they create a Family Investment Company with husband and wife as directors, and husband and wife plus their 3 children, who are over the age of 18, as shareholders. £1million of cash is transferred into the company, with no tax implications.

Since Mr and Mrs Brown wish to retain control over the company, the articles of association are drafted giving their children no voting rights; this means they are entitled to receive dividends but will not have the power to make financial decisions in the same way as other shareholders, although these rights could be altered in the future.

If the company makes profits corporation tax will be payable at the rate of 20% (from 1^st April 2015). The company can invest the cash into assets as decided by the directors.

Tax efficient cash withdrawals can be made in the form of dividends according to the personal circumstances of the shareholders and contributions to a company pension scheme can also be made. If shareholders do not have personal income in excess of the basic rate band, their dividends will not attract an income tax liability and if accumulated net profits are retained within the company no further tax is payable.

Other considerations to be aware of

• Assets transferred into a Family Investment Company can face a variety of treatments for tax purposes. For example:
  • Assets transferred to the ownership of the company have the potential to be inheritance tax free, provided the donor survives for seven years after the transfer, subject to tapering relief after three years;
  • Whilst cash can be transferred tax free, property and shares transferred to the company may be subject to capital gains tax at the rate of 28% if a gain arises based on the open market value of the assets.

• There are costs associated with setting up and maintaining a company; accounts and corporation tax returns must be prepared each year and an annual return should be filed with Companies House.

Our verdict

For taxpayers with large cash reserves that do not qualify for business property relief, a Family Investment Company can be tax efficient for inheritance tax planning, and for protecting wealth for future generations within the protection of a company. It can also be a useful tax planning strategy for families seeking a solution to university costs, because rather than financing their children’s studies through personal income, the company can be used. This has the potential to reduce the income tax payable because the effective tax rates are likely to be lower if the burden of tax is shared with the children who can utlise their dividend entitlements to cover the costs of study.

Finally, privately owned companies with significant cash reserves and no ongoing trade can be used as a Family Investment Company on an ongoing basis, without the need to extract the cash and incur additional tax liabilities.

If you are interested in discussing the pros and cons of establishing a Family Investment Company please contact Lesley Stalker by emailing las@rjp.co.uk.