Family investment companies: Facts about FICS – Corporate / Commercial law

A family investment company (FIC) structure is a useful tool for wealthy parents to pass on the future growth of their wealth to their children, without giving up the possibility of using the capital themselves in the future. It is therefore an Inheritance Tax Liability (IHT) freeze tool, rather than an IHT liability reduction tool.

In this article, we explain how FICs are structured, their advantages and disadvantages.

Structure

In its purest form, a corporation is incorporated and shares are awarded only to children. Parents lend money to the business and the business invests the money to generate a return.

The return on money is attributable to stocks owned by children, which gives children increased wealth over time, from their ownership in shares of a corporation with retained earnings fully attributable to the shares they hold. They hold. Parents will then use their loan account to finance their living expenses.

An FIC becomes more complex when parents want their children to benefit from the growth in the value of investments, but do not want them to have control over the business and investment decisions. In such a case, we favor a structure where the shares of the company are placed in one or more trusts: the beneficiaries of the trust are the children and the trustees are the parents.

This allows the parents to control the trust and therefore the voting rights of the trust shares, ultimately allowing the parents to control the FIC without the FIC shares being part of their estate for IHT purposes.

The FIC can be incorporated as a public limited company or as an unlimited company. The advantage of using a public limited company is that the information regarding the assets and liabilities of the company does not have to be entered in the public register: the information is provided annually to HMRC for corporate tax purposes. (CT).

A public limited company has no limited liability: the shareholders are ultimately responsible for all the commitments of the company. The type of business used should therefore be carefully considered.

If the ultimate goal is to reduce the value of the parents’ estate for IHT purposes, the loan asset held by the parents can be offered to the children. This would constitute a potentially exempt transfer (PET) for IHT purposes.

Parents should survive seven years from the date of donation to ensure that no IHT becomes payable on the loan donation to be received from parents to children. There is a relief granted when a parent survives more than three years but less than seven years.

Benefits of using an FIC

FICs are legal persons. The profits they generate are therefore subject to the CT (currently at 19% but which should increase to an effective rate of up to 25% as of April 1, 2023). If parents need cash, they can withdraw funds from the FIC to their loan account and incur no tax on the withdrawal as it is treated as a loan repayment.

In calculating the taxable profits of the company, expenses incurred in connection with investment management and investment advice are eligible expenses for the company and will be deducted from the income of the company. On the other hand, when these expenses are paid by an individual, they are not eligible for tax purposes and therefore cannot be deducted from the income received by the individual when calculating his taxable income.

When dividends are received by the company from equity investments, there is generally no TC payable by the company on such dividend income. This differs when received in the hands of an individual and dividend tax rates of up to 38.1% apply. The difference in tax treatment allows a greater amount of funds to be reinvested in the FIC, compared to individual ownership and reinvestment in equities.

It may be possible to add a gear in an FIC, borrowing against the invested assets so that additional assets can be purchased. Interest charged by the lender will be an eligible expense when calculating the profits attributable to CT. This differs for an individual, where such borrowing costs would not be deductible when calculating taxable income for income tax.

If additional income is requested by the parents, the loan they have made to the business may be subject to interest. Interest expense would be deductible when calculating the profits attributable to CT for the business. Parents would be taxed at the rate of income tax on interest.

When additional income is not required by parents, in the form of interest income, the loan should be recorded in the accounts as repayable on demand. This is to avoid HMRC’s potential claim that the interest-free loan is an addition to the trust, on which tax debts would be generated.

Disadvantages of using an FIC

There are costs associated with the initial setup of the FIC structure, as well as annual compliance costs for preparing accounts and tax returns for the business and the trusts that have been formed. These annual compliance costs are allowable expenses when calculating taxable profits, but result in cash transfers out of the FIC to settle amounts owed. Initial setup fees and structuring advice are not eligible expenses for tax purposes.

When the value of the shares in the trust is above the IHT threshold (currently £ 325,000), there is a tax charge every 10 years, known as the 10 year anniversary charge. The applicable tax rate is 6% of the value of the assets of the trust which exceeds the zero rate bracket of £ 325,000.

There is also an exit charge when assets are transferred out of the trust to the beneficiaries. It may therefore be advantageous for several trusts to be set up to hold shares in the company in order to avoid these charges: the operating costs of these should be taken into account in relation to the potential tax savings.

When profits are taken from the FIC, the FIC will have to declare a dividend. The dividend will be taxable in the hands of the trust, which will be taxed on the dividend at the rate of 38.1%. When the trust makes a distribution to the beneficiaries, the beneficiaries will be taxed on the dividend at income tax rates, claiming a credit for tax suffered on the dividend by the trust.

When investments are made for the purpose of creating earnings, an FIC is a less tax-efficient investment mechanism than if the investments were to be made personally. When investments are made personally, gains are taxed at the prevailing capital gains tax rate of 20%. If the investment was made through an FIC, the gain would be taxed at the current CT rate of 19%, but dividend tax rates would be applied when the profits are taken out of the FIC, resulting in a charge higher effective tax on the gain on the investment than if it were made personally.

You can also watch our webinar on CIF (2018).

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The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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