Inheritance TaxAug 17 2021

What next for family investment companies?

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What next for family investment companies?
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However, it is possible that apprehension linked to the review process could cause some wealthy families to be put off from using this effective planning tool.

The special investigation unit was established by HMRC in April 2019 to investigate the use of FICs at a time when they were becoming increasingly popular.

Specifically, HMRC had noted that FICs were being used as a tax planning vehicle, "often with the primary objective of generational wealth transfer and mitigation of inheritance tax". In undertaking the review, HMRC wanted to improve its understanding of FICs and how they were being used.

No cause for concern

Following a two-year review process, HMRC’s conclusion was that there is no cause for concern.

Minutes published from a meeting that took place in May 2021 state that the review found "no evidence to suggest that there was a correlation between those who establish a FIC structure and non-compliant behaviours". The unit has since been disbanded and subsumed into the wealthy and mid-sized business unit.

FICs have become more popular in recent years for a number of reasons. The ability to transfer generational wealth in a controlled and protected structure, and the mitigation of IHT, as cited by HMRC, are both key attractions.

As company structures, FICs are more familiar and commonplace than trusts, which has contributed to their popularity. Using a company to hold wealth can also significantly reduce an individual’s annual tax exposure when compared to personal tax rates.  

Legislation made family trusts less attractive

Legislative changes affecting family trusts, which took effect in 2006 making them rather unattractive from a tax perspective, mean it is now a significant challenge to pass wealth to the next generation without making them directly responsible for its management, with all the accompanying risks.

So, it is of little surprise that FICs have become the tax planning vehicle of choice for many wealthy families in recent years, particularly those that wish to pass wealth to the next generation tax-efficiently, while still maintaining an element of control.

By establishing an FIC, principal family members, such as parents or grandparents, are able to pass existing wealth to the next generation, or ensure that future capital growth passes to them, without compounding their existing IHT exposure.

Principal family members can determine benefits

The flexible nature of FICs also means these principal family members can determine how each member benefits by defining the rights attached to each class of share. By taking this approach, principal family members are able to ensure that income and capital pass to them in years to come. 

There are annual tax benefits too. For example, a 19 per cent rate of corporation tax is payable on profits and 0 per cent on company dividends. Even from 2023, this rate will continue unchanged for those companies with profits less than £50,000 and compares very favourably when compared to the personal tax rates, which would apply if the wealth had remained in personal ownership.

Where extra protection is needed for the next generation, or the FIC is designed to support a wider pool of beneficiaries, a hybrid FIC/trust structure is recommended.  

Despite the clear financial and practical benefits that FICs can bring when helping families to pass wealth to the next generation tax efficiently, the scrutiny they have faced over the past two years has discouraged some from adopting them as part of their planning strategies.

It must now be hoped that HMRC’s decision to draw a line under its investigation will improve confidence and encourage more families to consider it going forward.

More aggressive routes to IHT planning

The approach taken by HMRC in undertaking the review in the first place does beg the question ‘what was all the fuss about?’. As with most planning, there are more aggressive routes that one could take.

However, HMRC’s decision to disband its special investigation unit is a positive sign that the majority of those involved in creating FICs are doing so in the right way and in line with the intentions of tax law in this area.

To some extent, it seems that FICs may have been targeted unnecessarily, particularly as they are commonly used by families with average assets of £5m, rather than the extremely wealthy, who are more likely to establish a family office.

Despite giving them a clean bill of health as a legitimate tax planning tool, the fact that HMRC has stopped short of saying that FICs are no longer an area of interest means new legislation in this area cannot be ruled out.

Wealthy families seeking to adopt FICs as part of their planning strategy will have to weigh up the benefits they bring against the risk that changes could yet materialise at some point in the future.

With the capital gains tax rate expected to rise in the future to help cover the costs of the financial support provided during the pandemic, now may be the right time to establish a FIC structure and lock in the current low rate of CGT, while it remains an option.

Craig Hughes is a private client tax partner at accountancy firm Menzies LLP