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The 'Great Wealth Transfer'- the largest generational transfer of wealth in history - is approaching. The tax landscape, meanwhile, is becoming ever more complex. Against this backdrop, estate planning has become more crucial than ever. This represents a win-win opportunity for all. It ensures clients have an appropriate and efficient estate plan in place that benefits them and their beneficiaries by generating optimal outcomes. For advisers, it represents an opportunity to build relationships with the clients' wider network. This, in turn, can aid client retention, one of the biggest hurdles advisers will face during the 'Great Wealth Transfer'.
Read our report on Planning for the Great Wealth Transfer
There are numerous ways to transfer wealth, each with its own merits. For many years, trusts were the preferred method when control was a priority for the donor. However, changes to the relevant property regime for inheritance tax (IHT) in 2006 have led to a decline in the use of trusts among high-net-worth individuals. Since then, Family Investment Companies (FICs) have gained popularity as a mechanism to replace or complement discretionary trusts.
Transfers to ‘relevant property’ trusts in excess of the nil-rate band are chargeable at 20%, along with periodic and exit charges. Although FICs are less flexible, these charges do not apply, making them an attractive alternative for transferring wealth IHT-efficiently and in a controlled manner.
The FICs fix
In essence, FICs are companies that house a family’s long-term investments, such as stocks, shares, mutual funds, and potentially property. Expenses incurred by the FIC, including the investment manager’s fee, are generally deductible. Parents (known as founders) initially fund the FIC by directly subscribing for shares or making loans. Subsequently, some shares are gifted (as Potentially Exempt Transfers) to younger family members, who can benefit from the FIC at the appropriate time. Repayments of loans to founders are generally tax-free, ensuring parents are not left wanting, though outstanding loans remain within the estate.
Shares with voting rights retained by the parents enable them to maintain significant control over the operation of the company. As board members, they can determine the investment direction and decide when certain benefits are available to shareholders, including which shareholders receive dividends. Depending on the FIC’s structure (share type, memorandum, articles, and shareholders’ agreements), growth in value may emerge in the gifted shares. Because the sum of the parts may be less than the value of the whole, there may be additional IHT benefits. In other words, the shares retained by the founders for their own use may have a lower value in their estate for IHT purposes. Bespoke legal advice is essential for valuing a closed investment holding company according to voting rights, fractional ownership, and directors’ powers.
In addition to managing private client and trust wealth, Quilter Cheviot manages investments on behalf of companies, including FICs. A significant consideration in determining the appropriate holdings within the FIC is to minimise its own exposure to tax. Generally, corporates do not suffer corporation tax on dividends received from shares held directly. However, if held through other vehicles, tax can be artificially inflated or the timing changed, as noted in the loan relationship legislation from 1996 and 2008.
There is a considerable difference between income tax for wealth owned personally (up to 45%) and corporation tax for FICs (up to 25%). Note that profit will ultimately need to be extracted from the FIC, with the relevant taxation of dividends or Capital Gains Tax (CGT) where the company is wound up.
For those advising on wealth transfer for high-net-worth families where FICs have not been considered, certain valuable features may have been overlooked. In summary, these are:
- IHT: By creating multiple share classes at the outset, gifted shares, which leave the estate over seven years, will have specific rights to capital and subsequent growth. Additionally, the shares retained by the founder may have a lower value for IHT than their net asset value.
- Control: The recipients of the shares gifted by the founders may be restricted in their ability to sell or transfer what they have received.
- Engagement: Involving younger generations promotes a legacy of financial knowledge and stewardship, including, where appropriate, involvement in the company’s investment strategy.
FICs in action – a case study
Background
Mr and Mrs Smith want to provide financial help to their children as they grow older and start their careers. They are also concerned about grandchildren. Their children are in their teens, with the eldest about to start university. The Smiths aim to ensure they make considered financial decisions and avoid spending gifts made to them prematurely.
The Smiths run a successful trading company, soon to be sold, leaving them with £5m after tax, alongside other savings and pensions. Upon sale, exposure to IHT on their estate increases by the value no longer benefiting from Business Relief, should they pass prematurely.
Possible advantages of a Family Investment Company in this example
- Lower tax rates: Profits retained within the FIC attract lower tax rates (between zero and 25%) compared to Mr. Smith’s marginal rate of 45% and Mrs. Smith’s 40%.
- Potentially exempt transfers: Transfers of value become fully exempt if they survive for seven years, but with control over the shares given away.
- Increase in value: Future increases in investment value raise the company’s share value, benefiting the children’s and grandchildren’s shares outside their parents' estate.
- Dividend payments: Can be directed to the grandchildren when appropriate.
- Control: The Smiths retain influence over the company’s assets and dividend payments.
Key considerations
- Taxation: Some of the profits within the FIC, subsequently paid to shareholders may be taxed twice.
- Limited reliefs: FICs do not qualify for Business Relief.
- Unspent loans: Remain within the estate.
- Administrative costs: Running the company incurs legal and taxation obligations and costs.
Agreed action
Mr and Mrs Smith decide to use the proceeds of the sale of their company to subscribe for shares in a FIC, partly by way of a loan.
Company structure
Mr and Mrs Smith will be directors, and each issued one ‘A’ ordinary share. Two further classes of shares (B and C) will be created for their children and grandchildren, with no voting rights but entitled to capital and dividends, respectively. This structure allows dividends to be paid to the grandchildren as well as increasing the capital value of the shares given to their children as the company grows in value. Mr and Mrs Smith will initially subscribe to all shares and then gift a proportion of the B and C shares.
*Please note the case study above is for illustrative purposes only
FICs, estate planning and Quilter Cheviot
With decades of experience in supporting advisers with estate planning, we excel in understanding structures to create tailored solutions that meet the unique needs of each client. Our bespoke service ensures that every aspect of estate planning aligns with your client's financial goals and tax efficiency. Our team of experienced investment managers is dedicated to guiding you and your clients through how corporates can invest tax efficiently, helping to secure the financial future of your clients' loved ones.
This material is not tax, legal or accounting advice and should not be relied on for tax, legal or accounting purposes. Quilter Cheviot Limited does not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting adviser(s) before engaging in any transaction. Trusts, estate planning, taxation and inheritance tax advice are not regulated by the Financial Conduct Authority. Tax treatment depends on an individual's circumstances and may change in the future.
