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Family Investment Company structures scrutinised by new HMRC unit

Structuring your family investment companies (FICS) to avoid scrutiny from HMRC specialist unit

In April 2019, HM Revenue & Customs (HMRC) set up a specialist unit to analyse the tax benefits available from the use of so-called family investment companies (FICs). The existence of the unit was not publicised at the time but came to light earlier this year as the result of a Freedom of Information request. At this stage, HMRC remains tight-lipped about its policy objectives, though it has admitted that the focus will be on inheritance tax (IHT) advantages and their possible exploitation.

FICs have gradually emerged as a popular vehicle with which to pass family wealth down to subsequent generations, particularly in the wake of IHT regime changes for trusts and the steady decrease in corporation tax rates. The set-up costs, particularly drafting of share rights, mean that in practice a FIC will only be cost-effective if it is intended to hold assets in excess of £1 million.  

Allocating share rights accurately at the outset is imperative both for administrative and tax reasons, as later revisions may reduce the value of a shareholder’s estate with an eventual IHT cost. The various classes of share (a system of ‘alphabet shares’) will need to govern matters such as voting power at general meeting, power to transfer shares, distribution rights and the appointment of directors. Retention of parental control will be the driving policy in the early years of the company. 

The funds for the company are normally provided by way of an interest-free loan which enables the original funds to be extracted when the loan is repaid. Unlike an outright transfer of funds to a trust, a loan does not count as a transfer of value under IHT rules. HMRC could, however, invoke the settlements legislation to tax the lender on the income entitlements of other family members, on the grounds that the loan is uncommercial and so confers ‘bounty’ on them. With careful structuring, it should be possible to mitigate this risk. 

At some point, the decision will be made to start transferring shares to the next generation and we expect HMRC to look carefully at the effect of the class rights on the value transferred. A minority holding in a company is worth less for IHT purposes than the proportionate share of the company’s assets. To calculate the transfer of value, however, the donor’s own shares and those of their spouse are taken into account. HMRC might recommend that the interests of other family members be aggregated for this purpose, although such a move could risk arbitrary knock-on effects. 

Another strategy known to have been considered is to tax the undistributed income and capital gains within investment companies but to date this has not materialised. A further option for HMRC would be to introduce a higher corporation tax rate for investment, as opposed to trading, companies, a distinction which has been deployed before.

In principle, there is nothing inherently abusive about using a company as a wealth management vehicle, particularly where the alphabet share structure is determined at the outset. Our cautious prediction is that only if cumulative tinkering with the structure produces an artificial split between a shareholder’s or lender’s economic enjoyment and their taxability will future anti-avoidance legislation be likely to bite.

About the author

Rakesh Dabasia

+44 (0)20 7710 3135
DabasiaR@buzzacott.co.uk
LinkedIn

In April 2019, HM Revenue & Customs (HMRC) set up a specialist unit to analyse the tax benefits available from the use of so-called family investment companies (FICs). The existence of the unit was not publicised at the time but came to light earlier this year as the result of a Freedom of Information request. At this stage, HMRC remains tight-lipped about its policy objectives, though it has admitted that the focus will be on inheritance tax (IHT) advantages and their possible exploitation.

FICs have gradually emerged as a popular vehicle with which to pass family wealth down to subsequent generations, particularly in the wake of IHT regime changes for trusts and the steady decrease in corporation tax rates. The set-up costs, particularly drafting of share rights, mean that in practice a FIC will only be cost-effective if it is intended to hold assets in excess of £1 million.  

Allocating share rights accurately at the outset is imperative both for administrative and tax reasons, as later revisions may reduce the value of a shareholder’s estate with an eventual IHT cost. The various classes of share (a system of ‘alphabet shares’) will need to govern matters such as voting power at general meeting, power to transfer shares, distribution rights and the appointment of directors. Retention of parental control will be the driving policy in the early years of the company. 

The funds for the company are normally provided by way of an interest-free loan which enables the original funds to be extracted when the loan is repaid. Unlike an outright transfer of funds to a trust, a loan does not count as a transfer of value under IHT rules. HMRC could, however, invoke the settlements legislation to tax the lender on the income entitlements of other family members, on the grounds that the loan is uncommercial and so confers ‘bounty’ on them. With careful structuring, it should be possible to mitigate this risk. 

At some point, the decision will be made to start transferring shares to the next generation and we expect HMRC to look carefully at the effect of the class rights on the value transferred. A minority holding in a company is worth less for IHT purposes than the proportionate share of the company’s assets. To calculate the transfer of value, however, the donor’s own shares and those of their spouse are taken into account. HMRC might recommend that the interests of other family members be aggregated for this purpose, although such a move could risk arbitrary knock-on effects. 

Another strategy known to have been considered is to tax the undistributed income and capital gains within investment companies but to date this has not materialised. A further option for HMRC would be to introduce a higher corporation tax rate for investment, as opposed to trading, companies, a distinction which has been deployed before.

In principle, there is nothing inherently abusive about using a company as a wealth management vehicle, particularly where the alphabet share structure is determined at the outset. Our cautious prediction is that only if cumulative tinkering with the structure produces an artificial split between a shareholder’s or lender’s economic enjoyment and their taxability will future anti-avoidance legislation be likely to bite.

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If you would like help structuring your FIC or need a review to ensure it’s set up in the best possible way for your family, get in touch.

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