Families have used companies for investing their wealth for decades, so what is all the fuss about "Family Investment Companies" (FICs)? I think that the answer to that is not that FICs are new and different, it is more that since the 2006 Finance Act, the use of trusts, a very popular alternative, has become more difficult.
In my early career as an accountant, I knew little about trusts, – they were a "dark art". However, after working in the private client departments of two law firms for 25 years, I have long been a convert to trusts as the best vehicles for wealth preservation and family succession. Here I would like to share my enthusiasm for using trusts in conjunction with a company, rather than a company on its own.
The traditional scenario
Your clients are a married couple aged 55 and they sell their business for £10m. They could set up a company and retain the A shares which have voting rights only and gift their 20-year-old twins the B shares, that have a right to receive dividends and the capital on the wind-up of the company, but no right to vote. The parents then fund the company by a loan and fund their retirement by taking tax free withdrawals of the loan.
This works very well and by careful management of the loan your clients depart this planet in their 90th years having reduced their estate to less than £2m so they get the full £1m of IHT relief on their estate and the wealth has now transferred to their children. You have fulfilled the brief and done a great job. Or have you?
40 years after incorporation
The children are now 60 years old and with the loan now repaid and the investments grown, the investment company is worth £20m. They come in to see your firm (you have now retired) to discuss the following:
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The company being worth £20m, they now have an exposure to IHT of £8m so they are keen to gift the shares to the next generation to avoid that cost. The trouble is that gifting the shares to the next generation will trigger CGT of £4.8m so the company will need to pay a dividend of £6.9m to cover the income tax of £2.7m on the dividend and leave them with £4.8m to pay the CGT.
They are about to retire and were looking to enjoy an income from this company but now feel they have to gift most of their shares to their children. They are also conscious that if they retain some shares and pay themselves preferential dividends, that will be taxed as a gift with reservation of benefit.
The son announces that his marriage is going through a rocky patch and fears it will end in divorce. After the parents died, the company was reorganised to remove the "voting" A shares and create a single class of share. His divorce lawyer is concerned that exercise has converted his inheritance into matrimonial property. He also gave his wife 25% of his shares in order to utilise her £100,000 income threshold as this was needed to pay school fees.
The daughter is conscious that her children are 26 and 23 years old and just making their way in life. She is concerned that on gifting shares in the company to her children, they will be shareholders of the company, so will need to receive a copy of the accounts and at this point will realise that they are millionaires already having just left university. She is worried this will only encourage another gap year!
The Brodies FIC and how these problems are mitigated
The Brodies FIC does not create voting and income shares. Instead, it uses trusts.
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- Trusts are created to be the shareholders.
- The parents exercise control as trustees of the trusts and as directors of the company.
- The children (and grandchildren) receive an income as beneficiaries of the trust.
- The shares do not sit in the children's estate so they do not have to concern themselves at age 60 about their death triggering an IHT charge.
- This means that they do not have to gift the shares to their children, meaning that no capital gain is triggered and no additional income tax charge is created.
- The trusts are subject to a 6% IHT charge every ten years, but this is actually less than the CGT charge and can also be mitigated by additional steps, so is not a significant concern.
- Rather than gift their shares to their own children, the children can remain beneficiaries for life and receive an income from the company throughout their lifetimes.
- Grandchildren benefit by being paid funds from the trusts as needed.
- Spouses can be included (or not) as needed.
- With the son not being a shareholder, the shares in the company are not matrimonial property in Scotland and have greater protection on divorce in England and Wales.
- With the shares in trust, the grandchildren were introduced as beneficiaries of the trusts and their school fees were paid by the trusts. Based on fees of £25,000 per year (including VAT), paid for 17 years (school and university), the tax saving is £250,000 per grandchild.
- As the grandchildren are beneficiaries of the trusts and not shareholders of the company, they do not see any accounts and so have no idea of exactly how much wealth the family has.
Working with Brodies
Brodies have significant experience of implementing their FIC structure with trusts and tailor the structure to each family's needs and objectives.
- The first meeting – There is no charge for the initial meeting and we work with other professionals in advance of that meeting to create a "worked example". The objective of that is to give clients the best understanding of the structure.
- The second meeting – There is a charge for the second meeting, which is intended to consolidate understanding and to work to finalise the structure.
- A tax report is prepared – the advice given in meetings 1 and 2 is provided in writing and this gives the client time to pause before committing to the final implementation stage.
- Implementation – this is a co-ordinated process with a timetable agreed with the clients.
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Minimum value
In terms of value, the minimum capital sum really depends on what the clients have but the changes to the pension rules have changed the picture dramatically. For example, a client might have their home, £1m of investments, £850,000 of ISA and a pension worth £2.5m that they planned to leave to their children. The proposed changes to IHT on pensions from 2027 mean that clients now want to spend that pension which means they now want to do something with the investment portfolio. In this scenario, a FIC with trusts is very effective. The assets are arranged so that the clients retain access to a "rainy day" fund, but the growth on that fund arises in the FIC, outside the clients' estates and therefore passes to the children and grandchildren. In essence, the minimum value depends on age and context.
Cost
The price range for all of this is wide, as every client's circumstances are different so it is not possible to provide a universal quote for every scenario. However, here is guide:
| The first meeting | No charge |
| The second meeting | £1,500 + VAT |
| The tax report | £6,000 + VAT |
| Implementation | Cost is indicated at meeting 1 and agreed at meeting 2. |
| Ongoing costs | The only ongoing cost is the company accounts and tax return unless the client has a foreign domicile. |
Conclusion
The reasons why trusts were the preferred vehicle for family succession planning for decades remain, it is just that the change in the tax rules in 2006 and 2015 made it more difficult to use them. Brodies can assist clients to navigate that difficulty successfully. If you are interested in finding out more, please get in touch with our personal tax planning & compliance experts.
Contributor
Director of Personal Tax
