Family investment companies (FICs) are popular succession planning vehicles, enabling clients to pass wealth to the next generation whilst ensuring they retain control. They are increasingly being considered as alternatives to trusts, however, using them could saddle you with higher overall tax rates compared to personal holdings, and multi-generational tax planning complications.
What is a FIC?
FICs are private companies which hold and invest assets, typically structured with different classes of shares. Some share classes offer control (voting rights) with no/little economic rights (usually held by the founder(s)), whilst other classes provide economic rights with no control (usually held by the children). This enables the founder(s) to maintain control whilst passing the economic value to the children for IHT purposes.
Depending on how the FIC is funded and when the economic shares are gifted, there could be capital gains tax (CGT) consequences, and advice should be sought. The key advantage of a FIC is there is no upfront 20% IHT charge on creation.
Taxation of investments
Assets held by the FIC will be taxed at lower corporation tax rates (25%) rather than higher personal income tax rates (up to 45%), allowing investments to compound faster. The tax position can be further improved where certain investments are held, for example no tax will be due on dividends, or on the disposal of those shares if the conditions of the substantial shareholding exemption are met. However, we also need to consider how to extract value.
The first sting – extracting value
Value can be extracted by way of dividend (taxed at up to 39.35%) or by liquidation (taxed at up to 24%), creating a layer of double taxation. The total effective tax rate will depend on the investments held by the FIC, but in a worst case scenario results in a rate of 54.5% on income, and in a best case scenario 39.35% (the dividend rate).
The second sting – multi-generational planning
Whilst FICs may efficiently transfer value from generation one to generation two, the next generation is trickier. Generation two will personally hold the economic shares, which will likely hold significant gains. If they wish to pass that value to their own children pre-death, they risk significant dry CGT charges.
Whilst FICs can be the perfect vehicle for certain circumstances, they are often not as tax efficient as they may first appear. Professional advice is essential, but we would say that…