Family Companies
Written by Charlie Palmer on 07/03/2019

Problem:

Trust rates of tax are the highest in living memory. Income tax is 45%, plus exit charges and the 10 year tax charge to IHT.  Discretionary trusts are horrendously complex, with special legislation targeting them, such that any transfer into a trust that exceeds the settlor’s available nil rate band will trigger an immediate inheritance tax charge.

Solution:

Corporation tax rates are now just 19% - due to rise to 25% in 2022.  But you can put the assets into a company instead and the income is then subject to just the new 7.5% dividend tax (32.5% for higher rate payers & 38.1% for Additional rate earners above £100k pa).

So you can use this instead of trusts as your vehicle to transfer money down a generation. 

Set up a family investment company (FIC) to enable funds to be gifted, beyond the nil rate band and retain control with lower tax.  You know about the corporation tax, so what are the details on the company structure?

Firstly, most IFAs run their own limited companies, so at least practitioners is some help.  Essentially, it’s a private company where the shareholders in this case are the family members.  Parents can retain control over assets with voting shares, and involve the next generation with non voting shares.   But even better than that family members can lend their share certificates to the parents, who retain control that way.  A simple loan agreement will ensure that the parent who has borrowed the shares keeps voting control. 

It is smarter than a trust, because with a trust any transfer that exceeds the settlor’s available nil rate band will trigger an immediate inheritance tax charge.  Not so with companies.  Clever eh?

Cash transferred into the company can also be an interest free loan.  You could charge interest on the loan, and extract money that way too, although the income is subject to withholding tax.  And you could loan hard assets into the company in the same way - property, land, share certificates and chattels.  It will not be regarded as a transfer of value for IHT purposes and the loan can be extracted from the company later tax-free, or appropriate loan interest paid back less 20% withholding tax. 

Parents get the voting shares – so they get to control the operation.  Younger advisers should be aware just how worried elderly parents can get about their children getting divorced, and losing their fortune by having given it away to the soon-to-be-ex daughter in law.    

Next Gen who are hungry for their inheritance get either non voting shares – which can give them ownership without control, or voting shares that they immediately lend back to the parent.  Take care to set up individual agreements, but it stops family heads being voted off the board.  A smart way to the transfer of value, I’d say, because if you do this in a trust, the tax keeps getting tagged onto the Settlor, no matter how smart you think you are, the HMRC are absolutely onto this sort of Trust tax abuse.

Compare that to a discretionary trust where the funds are a PET going in and settlor cannot be a beneficiary.  Not so neat.  By using a Family Company you avoid the ten year IHT charge, and the high rate of dividend tax in discretionary trusts and de-couple the settlor.   One problem is that capital gains realised by the company are chargeable to corporation tax at 19% from 2021, rising to 25%, and you also lose the personal exemption of £12k pa or so.  That is not so good – until you compare it to individual CGT that is taxed at 28% above the nil rate band.  

When it comes to dividends received by the Family Company they are largely exempt from corporation tax – so no ongoing corporation tax for a pure play share portfolio in the Family Company.   

The company will also get a corporation tax deduction for interest on loans taken out against the value of its investments, where the loans are used for the purposes of the company’s business (eg acquiring new shares in that same portfolio!).  For the shareholders in the company, on a personal tax basis, their tax return will be the same as for any holding of shares in any other private limited company, and broadly as follows:

  • Income tax on dividends: Nil taxpayers will have no liability, basic rate taxpayers 7.5%, higher rate taxpayers at 32.5% and additional rate taxpayers at 38.1%. Dividend allowance is nil rate up to a cumulative £2,000 of dividends in a tax year.
  • Income tax and National Insurance on any salaries received 
  • CGT on the liquidation of the company – usually at 20% for higher rate taxpayers.

Family investment companies is a winner, and should be in the armoury of all IFAs when dealing with inheritance.

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