Why you should take care with family investment companies

Interest in the use of family investment companies (FICs) appears to grow year on year, with renewed interest since the Autumn Budget inheritance tax (IHT) announcements about the changes affecting trusts, the proposed cap on agricultural and business property reliefs from April 2026 and undrawn pensions becoming liable to IHT from 2027. Although FICs can be robust structures, care is always required in their creation and use. The purpose of this article is not to comment in detail on the tax position of FICs, but rather to provide a brief overview of areas to which practitioners should give specific focus – particularly when establishing more complex FICs for clients.

It is often stated that HMRC is comfortable with FICs. This assertion is based on a two-year review of the FIC concept by a specialist unit of HMRC (ending in 2021). This review concluded (item 5) that there was no correlation between the use of FICs and the failure to report one’s tax affairs correctly. While this provides a level of comfort, it would be wrong to conclude that FICs are beyond challenge or that there are not traps for the unwary. HMRC has not precluded itself from challenging the structure of FICs in future. 

All relevant taxes should be considered in detail when a FIC is to be established. A FIC is seldom an ‘off-the-shelf’ solution.

A typical FIC structure

A FIC is normally a UK-incorporated and resident company that holds investment assets (eg, real estate or stocks and shares). In many cases, the FIC is an unlimited company to assist with privacy. The directors of the FIC are normally the individuals (typically, husband and wife) who created the FIC. For ease, in this article the individual who created the FIC is called ‘the founder’.

FICs are normally created to: 

1. provide a vehicle for holding a wide range of investments and accessing corporation tax rates, which may be lower than individual tax rates; and/or
2. as part of a succession and IHT planning strategy.

In line with the above, the shareholders of the FIC will normally be members of the same family. For example, the founder may form the FIC and hold shares in it, but also vest shares in their children. The children’s shares may often have specific rights, either enabling the parents to retain voting control or decide when the children should receive dividends and so on, or only enabling the children to benefit from the future growth in the value of the FIC. 

Consideration should be given as to whether a charge arises under the employment-related securities legislation when shares are issued to or transferred to family members, including where there are issues of bonus shares or rights shares prior to a transfer.

FICs are normally funded by cash. This is because there can be capital gains tax (CGT) charges (based on market value, as family members will be connected) if assets standing at a gain are transferred to the FIC, or charges to stamp duty land tax (or similar taxes in Scotland and Wales) on the transfer of UK real estate to the FIC.

Where shares in the FIC are gifted, the FIC may not qualify as a trading company for the purpose of CGT gift holdover relief or business asset disposal relief (BADR). Therefore, consideration needs to be given to how CGT liabilities will be funded if capital gains exceed the annual exempt amount (currently £3,000). We cover the valuations of shares based on different share rights later in this article.

The following paragraphs outline some of the key tax issues to be considered when creating a FIC.

Corporation tax

The FIC is subject to the corporation tax regime and is likely to be a close investment holding company (CIHC), meaning that it does not benefit from the small profits rate of corporation tax or marginal relief. Key points include that corporation tax rates are paid on capital gains (although at present the personal CGT rates are lower), dividends may be received tax free by the FIC in many circumstances and the possibility of a deduction for management expenses.

However, it is important to remember that the FIC is subject to the specific corporation tax rules, such as the loan relationship rules, which not all private client practitioners may have a detailed knowledge of. This can result in unexpected consequences (eg, as to the timing of tax charges) and so private client practitioners should liaise with their corporate tax colleagues when creating a FIC to hold assets which may possibly fall within the loan relationship rules. 

Funding the FIC

Funding of a FIC is an area where practitioners should take particular care. Many FICs are funded by a loan. The advantage of the loan is that it enables the person making the loan to extract funds from the FIC without a personal tax charge (although there will normally be a corporation tax charge when assets are disposed of by the FIC to repay the loan). Some FICs are created using redeemable preference shares instead of a loan. This is on the basis that some advisers are concerned that the repayment of the loan may potentially fall within scope of the transactions in securities legislation (Pt 15, Corporation Tax Act 2010; Ch 1, Pt 13, Income Tax Act 2007 (ITA 2007)).

Where a loan is used, it is often interest free, although sometimes interest is charged. Advisers should consider if interest is appropriate having regard to a number of issues including that the payment of interest: 

• may, depending on the facts, help reduce any concerns around the application of the settlements legislation (see below). This is because it may support the view that either there is no bounty (depending on other circumstances), or that the settlor does not have a retained interest (in cases where the loan is his only interest in the income and it can be said that the interest rate means that repayment of the loan is not a benefit for the recipient); 
• may support the argument that the arrangements were not entered into for the purpose of gaining an income tax advantage thereby reducing the risk of a charge under the transaction in securities legislation (see above and s684, ITA 2007); and
• it may reduce the concern of whether transfer pricing rules apply to a FIC.

It should be remembered that the loan interest will be taxable on the recipient. 

Care is also required when further capital is contributed to the FIC. Funds contributed to a FIC are not potentially exempt transfers and so there could be an immediately chargeable transfer for IHT purposes, depending on the share structure at the time of any further contribution. Where a loan is used, the loan is normally repayable on demand to avoid a transfer of value for IHT purposes.

The IHT gift with reservation of benefit (GWR) provisions should also be considered in relation to the funding (and structuring) of the FIC. HMRC's guidance suggests that an interest-free loan repayable on demand is not, in itself, a GWR. However, not all commentators may agree with this view and the position should be considered in the light of the specific facts surrounding the FIC. 

The GWR provisions should also be considered in other aspects of the formation of a FIC. For example, is there a potential GWR concern if a founder funds an FIC, but has an ability to influence the payment of dividends to certain shareholders to the exclusion of others?

Share rights 

In many cases, the attraction of a FIC is the ability for the founder to retain control over the passing of wealth, by the incorporation of specific provisions in the FIC’s articles of association (or sometimes via a shareholders’ agreement). A FIC may be also incorporated with ‘alphabet’ shares to facilitate the payment of dividends to some shareholders but not others. The founders usually retain the voting rights. 

The articles require careful drafting, but depending on their precise terms, a number of tax provisions must also be considered at the time of their preparation, including in the following areas.

Omission to exercise a right

Section 3(3), Inheritance Tax Act 1984 (IHTA 1984) provides that there can be a disposition for IHT purposes by a person’s omission to exercise a right. This may be an issue (for example) if a dominant shareholder (in terms of voting rights) fails to exercise their rights to take dividends and instead diverts the dividend to another shareholder. Articles should be reviewed in the context of s3(3).

Alteration of capital, and so on

The application of s98, IHTA 1984 can result in a disposition for IHT purposes where there is an alteration in the rights of shares. Many FICs incorporate ‘freezer’ or ‘growth shares’ where family members (or trusts for their benefits) are given growth shares. The growth shares have little or no present value (which makes them good assets for giving away), but will receive value over time when (hopefully) the value of the FIC increases. Section 98 should be in mind when drafting the growth mechanism (and associated ‘hurdle’). The section should not normally bite where the articles are drafted in such a way that when the ‘hurdle’ point is reached, and the growth shares begin to rise in value, there is simply a flowering of pre-existing rights as opposed to an acquisition of new rights or shares.

The settlements legislation

Close attention should be paid to the settlements legislation (Ch 5, Pt 5, Income Tax (Trading and Other Income) Act 2005). The FIC can be a ‘settlement’ for these purposes within the wide definition of that term in s620 and these provisions need to be considered in the context of FIC share rights. There cannot be a ‘settlement’ unless there is an element of ‘bounty’. In many cases, there may be gifts between family members that will result in ‘bounty’ being present, but this will not always be the case. 

Care may be required, for example, if it is contemplated that dividends might be paid to minor children (s629), or if shares are to be given to a spouse (s624), although in many cases the ‘outright gift’ to a spouse/ civil partner exemption in s626 would apply on the basis that the shares given have rights such as to ensure that they could not be regarded as being wholly or mainly a right to income. Where ‘alphabet’ shares are used in a FIC, consideration should be given to the rules on income shifting in the settlement legislation. 

The breadth of the settlement code is such that it should be front of mind when advising on a FIC. One might argue that a FIC in which a founder retains some share or loan interest could fall in its entirety within s624. If this argument were correct on the facts, it would allow HMRC to pierce the corporate veil and tax the Founder of the FIC on all or some part of its income. In practice, HMRC does not seem to be inclined to challenge FIC structures to this extent on the basis of the settlement provisions.

Valuation

Share valuations should also be considered when advising on a FIC. Matters to consider in this context include:

• where shares in the FIC are widely held, the possible impact of minority discounts for the purposes of IHT; and
• where clients who create FICs wish to retain voting control (so that they can regulate when and how family members benefit from the FIC), that may result in an increase in the value retained by the founder. This may impact on the effectiveness of the FIC as an IHT planning vehicle.

Offshore FICs

Most FICs are established as UK incorporated companies. A FIC can however be established in an offshore jurisdiction. In addition to the above considerations, there are other issues to have regard to when advising on the establishment of an offshore FIC including the following: 

• The residence of the FIC. Many offshore FICs are made UK resident to avoid the potential impact of the income tax and CGT anti-avoidance provisions (s720, ITA 2007 and s3, Taxation of Chargeable Gains Act 1992) (although one may still need to consider the income tax provisions if the FIC if established offshore). 
• Where the founder was (formerly) a non-UK domiciled individual using the remittance basis, remittance issues should be considered in relation to the funding of the FIC and generally the FIC may have to be restricted to non-UK situs assets. 
• Any local tax considerations in the jurisdiction in which the FIC is founded. 

Conclusion

FICs are widely used and can be an effective solution for clients. Correctly structured they are also tax efficient and unlikely to be viewed by HMRC as an aggressive planning technique. However, the tax position of a FIC can be very fact specific (especially where there are complex articles of association or complex funding structures) and FICs are potentially subject to anti avoidance legislation. As such, practitioners should proceed with care, particularly in the case of more complex FICs, and should bear in mind, as required by Professional Conduct in Relation to Taxation (PCRT), that they are suitably experienced before advising taxpayers.