As we approach the 'Great Wealth Transfer'—the largest generational wealth transfer in history—and navigate an increasingly complex tax landscape, estate planning has become more crucial than ever. Ensuring that clients have an appropriate and efficient estate plan in place not only benefits the client and their beneficiaries by ensuring optimal outcomes but also helps build relationships with the clients' wider network. This, in turn, aids in 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 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 those looking to save on IHT, in a controlled manner.
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, or PETs) 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.
Shares with voting rights retained by the parents enable them to maintain significant control over the FIC. As board members, they can determine the investment direction and decide when any benefits to shareholders are provided, 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 close 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 Family Investment Companies. A significant consideration in determining the appropriate holdings within the FIC is to minimise its exposure to tax. Generally, corporates do not suffer Corporation Tax on dividends received from shares held directly. However, if held through other vehicles by most companies, tax can be artificially inflated or the timing changed, as noted in the loan relationship legislation from 1996 and 2008. Additionally, 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 are 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.
