As we approach the ‘Great Wealth Transfer’—the largest generational wealth transfer in history—and navigate an increasingly complex tax landscape, estate planning has become more crucial than ever. Ensuring that clients have an appropriate and efficient estate plan in place not only benefits the client and their beneficiaries by ensuring optimal outcomes but also helps build relationships with the clients’ wider network. This, in turn, aids in client retention, one of the biggest hurdles advisers will face during the ‘Great Wealth Transfer’.
Read our report on Planning for the Great Wealth Transfer here.
There are numerous ways to transfer wealth, each with its own merits. For many years, trusts were the preferred method when control was a priority for the donor. However, changes to the relevant property regime for inheritance tax (IHT) in 2006 have led to a decline in the use of trusts among high-net-worth individuals. Since then, Family Investment Companies (FICs) have gained popularity as a mechanism to replace or complement discretionary trusts. Transfers to trusts in excess of the nil rate band are chargeable at 20%, along with periodic and exit charges. Although FICs are less flexible, these charges do not apply, making them an attractive alternative for those looking to save on IHT, in a controlled manner.
In essence, FICs are companies that house a family’s long-term investments, such as stocks, shares, mutual funds, and potentially property. Expenses incurred by the FIC, including the investment manager’s fee, are generally deductible. Parents (known as founders) initially fund the FIC by directly subscribing for shares or making loans. Subsequently, some shares are gifted (as Potentially Exempt Transfers, or PETs) to younger family members, who can benefit from the FIC at the appropriate time. Repayments of loans to founders are generally tax-free, ensuring parents are not left wanting.
Shares with voting rights retained by the parents enable them to maintain significant control over the FIC. As board members, they can determine the investment direction and decide when any benefits to shareholders are provided, including which shareholders receive dividends. Depending on the FIC’s structure (share type, memorandum, articles, and shareholders’ agreements), growth in value may emerge in the gifted shares. Because the sum of the parts may be less than the value of the whole, there may be additional IHT benefits. In other words, the shares retained by the founders for their own use may have a lower value in their estate for IHT purposes. Bespoke legal advice is essential for valuing a close investment holding company according to voting rights, fractional ownership, and directors’ powers.
In addition to managing private client and trust wealth, Quilter Cheviot manages investments on behalf of companies, including Family Investment Companies. A significant consideration in determining the appropriate holdings within the FIC is to minimise its exposure to tax. Generally, corporates do not suffer Corporation Tax on dividends received from shares held directly. However, if held through other vehicles by most companies, tax can be artificially inflated or the timing changed, as noted in the loan relationship legislation from 1996 and 2008. Additionally, there is a considerable difference between income tax for wealth owned personally (up to 45%) and corporation tax for FICs (up to 25%). Note that profit will ultimately need to be extracted from the FIC, with the relevant taxation of dividends or Capital Gains Tax (CGT) where the company is wound up.
For those advising on wealth transfer for high-net-worth families where FICs have not been considered, certain valuable features may have been overlooked. In summary, these are:
- IHT: By creating multiple share classes at the outset, gifted shares, which leave the estate over seven years, will have specific rights to capital and subsequent growth. Additionally, the shares retained by the founder may have a lower value for IHT than their net asset value.
- Control: The recipients of the shares gifted by the founders are restricted in their ability to sell or transfer what they have received.
- Engagement: Involving younger generations promotes a legacy of financial knowledge and stewardship, including, where appropriate, involvement in the company’s investment strategy.
FICs in action – a case study
Background
Mr. Smith wants to provide financial help to his children as they grow older and start their careers. His children are in their teens, with the eldest about to start university. Mr. Smith aims to ensure they make considered financial decisions and avoid taking a series of ‘gap years’.
Mr. Smith runs a successful company with his wife, who takes a more background role. They have built up an investment portfolio and own four residential properties, with the acquisition of the final two partly funded by borrowing. All their assets are jointly owned. Mr. Smith is planning for the future and considering ways to mitigate future inheritance tax (IHT) obligations.
Current status
- Annual income: Mr. Smith earns approximately £150,000. His wife is a higher rate taxpayer.
- Company shares: Held equally by Mr. and Mrs. Smith, qualifying for 100% business property relief.
- Business asset disposal relief: Both qualify in the event of a sale.
- Investment and rental properties: Worth £3.5 million.
- Main residence: Worth £1 million.
- Recent inheritance: £1.5 million.
Advantages of a Family Investment Company (FIC) in this example
- Lower tax rates: Income retained within the FIC attracts lower tax rates (up to 25%) compared to Mr. Smith’s marginal rate of 45% and Mrs. Smith’s 40%.
- Interest relief: Transferring rental properties to the FIC allows full interest relief, though capital gains tax and SDLT are likely to apply.
- Potentially exempt transfers: Transfers of value become fully exempt if they survive for seven years.
- Increase in value: Future increases in investment value raise the company’s share value, benefiting the children’s shares outside their parents’ estate.
- Dividend payments: Can be directed to the children when appropriate
- Control: Mr. and Mrs. Smith retain influence over the company’s assets and dividend payments.
Key considerations
- Double taxation: gains within the FIC, subsequently paid to shareholders may be taxed twice.
- Dividends to minors: Care is needed to ensure dividends paid to their minor children are not taxed on Mr. and Mrs. Smith.
- Limited reliefs: FICs do not qualify for Business Relief.
- Administrative costs: Running the company incurs administrative obligations and costs.
Agreed action
Mr. and Mrs. Smith decide to use their £1.5 million inheritance to subscribe to shares in the company, some of which will be given to the children. Any transfer by way of a loan is repayable to them without tax but remains within their estate.
Company structure
Mr. and Mrs. Smith will be directors, and each issued one ‘A’ ordinary share. Three further classes of ordinary shares (B, C, and D) will be created for the children, with no voting rights but entitled to dividends. This structure allows dividends to be paid to the children once they reach 18 and increases the capital value of their shares as the company grows. Mr. and Mrs. Smith will initially subscribe to all shares and then gift the B, C, and D shares to their children. To ensure value passes to the children, 100 shares of each class will be created to swamp the A shares, ensuring a potentially exempt transfer.
*Please note the case study above is for illustrative purposes only
FICs, estate planning and Quilter Cheviot
At Quilter Cheviot, we offer comprehensive support in managing Family Investment Companies (FICs) and trust investments. With decades of experience in supporting advisers with estate planning, we excel in understanding structures to create tailored solutions that meet the unique needs of each client. Our bespoke service ensures that every aspect of estate planning aligns with your client’s financial goals and tax efficiency. Our team of experienced investment managers is dedicated to guiding you and your clients through these complexities, helping to secure the financial future of your clients’ loved ones.
