If you want to give something away but retain some control over it, chances are that an English lawyer will tell you to use a trust.
I am a great fan of trusts but, let’s be honest, they have
some potential drawbacks. For example,
if an individual puts more than £325,000 into trust, a 20% Inheritance Tax (IHT)
entry charge could be payable. Most trustees
currently pay Income Tax at between 37.5% and 45% and Capital Gains Tax (CGT) at
28%, which leaves less after tax to reinvest.
It is also very difficult to prevent beneficiaries interfering in the trust
administration completely – the whole premise of a trust is that the trustees
have to be accountable to the beneficiaries.
Laudable but not always wanted.
In many cases, with proper tax planning and a carefully
crafted trust deed, most of these potential drawbacks can be managed. But, let’s be radical and think the
unthinkable, are there any alternatives to trusts out there? Cue the FIC (Family Investment Company).
Here’s an example of how a simple FIC might work. Mr and Mrs Smith want to give their two
children, Tim and Tom, £450,000 each, but retain control over how the children access
the money. Rather than giving them £450,000
each, the Smiths could create a FIC – a regular company but whose purpose is to
invest the money it receives by way of subscription. The Smiths can be the directors and control
the investment activity of the company.
They subscribe for shares. This
is the clever bit as, by issuing ordinary shares, perhaps of different classes,
and tailoring the rights attached to each class, the Smiths can craft the FIC around
their own family’s requirements. They
could subscribe for, say, £300,000 of ordinary ‘A’, ‘B’ and ‘C’ £1 shares. Voting rights would attach to the ‘C’ shares
only. The Smiths then give the ‘A’ shares
to Tim, the ‘B’ shares to Tom (these are Potentially Exempt Transfers (PETs) by
the Smiths for IHT purposes) and the ‘C’ shares to a trust for Tim and Tom
(this is a Chargeable Lifetime Transfer (CLT) but will not trigger an IHT entry
charge unless the Smiths are in the habit of making gifts to trusts or
companies). The Smiths can be the trustees. Appropriate share transmission restrictions
prevent Tim and Tom selling their shares.
The rights attached to the shares would allow
the directors to determine when dividends were declared and on which class of
share dividends were paid.
For tax purposes, FICs come into their own when the aim is
for long-term retention of family money in the structure, not short-term
distributions. There are two layers of
taxation of course – taxation at the company level and taxation at the
shareholder level. Broadly speaking,
FICs that just invest in other companies’ shares receive dividends tax free, so
gross roll up of dividend income is possible.
Changes of investments will give rise to Corporation Tax, if they are
standing at a gain on disposal, but currently payable at 21% with indexation
allowance available (compared to 28% CGT and no indexation allowance for
individuals). So more profit is
available for reinvestment. Should the
FIC pay dividends, a basic rate shareholder will have no further tax to pay –
ideal for teens and twentysomething children perhaps. If a partial return of capital at some stage
is envisaged at the outset, preference shares can be issued to the children as
well, structured so that the timing of the redemption is at the directors’
If a FIC’s constitution prohibits shares being transferred
to non family members, the FIC should be an effective vehicle to prevent family
wealth being lost to a child’s spouse on divorce.
If the family is prepared to take the risk, the FIC could
be an unlimited company, thereby avoiding the need to maintain a record of the
shareholders at Companies House and file accounts. If all the FIC is doing is investing on the
stock market, the risk associated with unlimited liability should be negligible.
In the right situation, a FIC is worth considering. Why aren’t more lawyers talking about them?