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HMRC's new Family Investment Companies team: How family offices and ultra-wealthy individuals can protect themselves

In late February, news broke that HM Revenue and Customs (HMRC) has set up a new team to investigate the use of Family Investment Companies (FICS) with a focus on Inheritance Tax (IHT).

In late February, news broke that HM Revenue and Customs (HMRC) has set up a new team to investigate the use of Family Investment Companies (FICS) with a focus on Inheritance Tax (IHT).

FICs have become popular with family offices, HNW and UNHW individuals in recent years. The concept of a FIC is similar to a trust whereby parent or grandparent ‘settlors’ retain control by subscribing for A shares which give them control in the form of voting rights. Younger generations subscribe for B/C shares which allow them to receive dividends and capital on the winding up of the FIC. However, unlike a trust, an unlimited amount can be settled without an upfront IHT charge.

There are two ways to settle a FIC. Firstly, parents can lend the FIC cash to invest, normally in an equity heavy portfolio. Any growth in the value of the investments will accrue to the economic B/C shareholders and the board can pay dividends to those shareholders. There is little IHT advantage in parents making a loan to a FIC as, whilst the loan is outstanding, it will remain in their estates for IHT. However, parents can draw down on the loan, free of Income Tax and Capital Gains Tax (CGT) and spend the cash. Alternatively, they can gift the loan to the next generation in the future. That will be a Potentially Exempt Transfer (PET) for IHT purposes and, provided the parents survive for more than seven years, the PET will fall out of their estates for IHT.

The second way of seeding a FIC is for parents to make a gift of cash to children/grandchildren who then use the cash to subscribe for shares in the FIC. This gift will be a PET which the parents will need to survive for more than seven years. Again, a gift of cash does not seem to be particularly controversial from an IHT planning perspective.

The separation of economic ownership and the control means that most of the value of the FIC will eventually be with the children/grandchildren for IHT purposes. However, the A shares will still have some value. The more voting rights the A shares have, the more HMRC is likely to argue they are worth. Certainly, if the A shares give the holders 75% or more of the voting rights they will have significant value as the A shareholders will be able to pass special resolutions including changing the Articles of Association. For this reason it is prudent to spread voting rights between all classes of shares when the FIC is incorporated.

It may be that as part of their review, HMRC will be focusing on existing structures where share rights have been altered and value has shifted. Generally, if share rights are as flexible as possible when the FIC is incorporated there should be no need to alter those when family circumstances change. One way to achieve flexibility is to incorporate a family trust into the FIC structure which holds ‘T’ shares. The trust can benefit future born generations without having to carve out rights from existing share classes which could constitute value shifting and therefore have IHT and CGT implications.

Families should ensure that FICs are not being used for aggressive Income Tax avoidance. For example, it is possible to roll up dividend income tax free of Corporation Tax within the FIC structure and reinvest this. However, if the board declare no or very few dividends to the B/C shareholders, there will be no Income Tax in their hands. The Board could wind up the FIC after a relatively short timeframe with the shareholders receiving a capital payment. Prima facie, the shareholders would be liable for CGT at 20% rather than income Tax at 38.1%. Such behaviour is likely to trigger an enquiry by HMRC and should be avoided.

It is also possible that the government could change how FICs are taxed. For example, a split Corporation Tax rate could be introduced with investment companies paying a higher rate in line with personal Income Tax rates. It has also been suggested that lifetime gifts of more than £30,000 might be liable for an immediate IHT charge of 10% and gifts over £2 million at 20%. This would have an effect on IHT planning generally, but a FIC settled with a loan could be a solution.

Provided that the FIC is structured to ‘future proof’ it as far as possible from the outset and that it is run as a genuine investment vehicle to benefit family members it seems unlikely that HMRC will succeed in an argument that FICs are, on the face of it, unacceptable tax avoidance. Indeed, the outcome of HMRC’s investigation should provide helpful guidance on how HMRC view FICs and best practice for incorporating and running them.