top of page
  • Katherine Bullock

Onshore to Offshore: FICs Part II: Why you may prefer vanilla



The taxation of Family Investment Companies (FICs) depends upon how they are structured and where they are located. These two aspects need careful thought and analysis. There are also a wide number of different tax provisions that may apply and require careful thought. All of this can make tax something of a minefield. In this post, I have set out to provide some initial thoughts around two key questions: How are FICs taxed on a day-to-day basis and how are they taxed with relation to IHT? The first is relatively straightforward, and the second requires more detailed analysis. However, neither should be contemplated without professional advice.


"...FICs have the potential to grant manifold benefits to those using them..."

To begin with, a UK-resident FIC is potentially liable to double-layered taxation. This is because the profits from the company are taxed first to corporation tax as one might expect. The second layer of tax comes on the extraction of the post-tax profits from the company and this will depend on how that extraction takes place. While the rate of corporation tax is currently lower than the higher-rate of income tax, expected increases to corporation tax rates may reverse that situation. However, to the extent that the FIC receives exempt dividends, there is no corporation tax to pay. Further the second layer of tax can be deferred so long as the profits are left to accumulate in the FIC. As a result an FIC can make an excellent vehicle for long-term wealth accumulation for succession purposes.

This leads us neatly onto the question of how an FIC might be treated for IHT purposes. Firstly, capital introduced by the founder into the company in exchange for shares with broadly the same value as the capital contributed should not give rise to a reduction in the founder’s estate for IHT purposes. If instead the founder gifts assets to the FIC, there will be a chargeable lifetime transfer, although if the founder owns 100% of the shares in the company it may be argued that any diminution in the value of his estate is minimal. The gift may also give rise to a chargeable gain for Capital Gains Tax purposes. A third option is for assets to be sold to the FIC, and this will normally be a sale at, or deemed to be at, market value. Again this may give rise to a disposal for CGT purposes and SD/SDLT depending on the asset, but no IHT charge should arise.

The gift of shares in the FIC should be potentially exempt from IHT and therefore should fall outside the founder’s estate once seven years from the date of the gift have passed. In practice, the potential IHT liability during this seven-year period is often insured against. It is critical to ensure that there is no gift with reservation of benefit where the founder retains shares and there are a number of traps that must be avoided here.

There is another advantage from an IHT perspective. Transferring shares to other individuals means that the value of the shares retained will normally be subject to a discount when valued because they represent a smaller proportion of the shares in issue. This gives rise to an immediate IHT saving without any requirement to survive seven years. Any growth on the value of the gifted shares occurs outside the founder’s estate in a tax efficient entity. With current global inflation this is no longer a largely neutral factor!

The FIC does not fall within the relevant property regime that applies to trusts for IHT purposes and so is not subject to 10-year charges or exit charges.

All of this certainly sounds appealing, but as mentioned above there are numerous pitfalls that must be carefully circumnavigated for the structure to function as required. Firstly, the settlement legislation prevents an individual from gaining a tax advantage by diverting their income to another person who pays less or no income tax. It does this by taxing the settlor. HMRC have expressed the view – although not yet taken in practice – that when an interest free loan is made to a company and dividends are paid to family members, all or part of those dividends should be taxable on the lender not the shareholder as the loan is a form of settlement. These provisions therefore require careful thought where an FIC is funded by way of loan.

FICs are also particularly vulnerable to attack under the settlement code where different family members have subscribed for Alphabet shares and a spouse or minor child can benefit, although it is worth noting that a benefit can still arise to the settlor if income is paid to a third party eg in the case with adult children. Here the risk of challenge can be reduced by limiting the rights attaching to each class of shares.

Transactions in securities provisions may also apply. This code may need to be considered where a loan is connected to a subscription for shares. Loan repayments from the profits of an FIC are unlikely to be relevant consideration if there has been a genuine loan. However, the more extreme the circumstances the more likely HMRC are to establish the necessary purpose. The regime may also require consideration where there has been non-payment of dividends followed by liquidation after a relatively short period of time.

Dividends paid out to one class to the detriment of another may result in a value shift. Take care especially where share rights are adjusted, and the FIC is a close company. An alteration in share rights that reduces the value of a participator’s interest in the company may give rise to a chargeable lifetime transfer for IHT purposes. Be careful not to inadvertently trigger these provisions!

Interest free loans may be subject to a transfer pricing (TP) adjustment. The TP regime may apply where the FIC and the lender are related parties and can apply to transactions between individuals and companies. The difficulties arising on loans to FICs under these rules and the settlement and transactions in securities regimes is of course avoided if interest is charged or if redeemable preference shares are utilised instead.

The Disclosure of Tax Avoidance Schemes (DOTAS) rules must also be carefully considered in more complex cases. Last but not least, think about the General Anti-Avoidance Rules (GAAR), since although they are unlikely to apply, triggering them nonetheless would be hugely detrimental.

In summary, FICs have the potential to grant manifold benefits to those using them, allowing for efficient holding and accumulation of wealth while avoiding unnecessary exposure to IHT when structured carefully in line with the tax legislation and the requirements for filing and disclosure. They function best when kept simple and pure of purpose, and when their limitations are recognised and appreciated. So long as this is kept in mind, they can prove to be an invaluable tool for planning for succession.

Comments


bottom of page