Navigating the Fiscal Landscape of FICs

When considering a Family Investment Company (FIC) as part of your wealth management strategy, understanding the tax implications is crucial. FICs can offer significant tax advantages, but they also come with complexities that require careful navigation. Let’s dive deep into the various tax considerations associated with FICs.

Corporation Tax

One of the primary tax advantages of an FIC is that it’s subject to corporation tax rather than income tax. This can result in significant savings, especially for higher and additional rate taxpayers.

Current Rates and Thresholds

As of the 2023/24 tax year:

  • Companies with profits up to £50,000 pay corporation tax at 19%
  • Companies with profits between £50,000 and £250,000 pay a marginal rate that increases from 19% to 25%
  • Companies with profits over £250,000 pay corporation tax at 25%

Let’s consider an example:

The Johnson FIC generates £300,000 in profit from its investments. If this income had been received directly by Mr. Johnson (an additional rate taxpayer), he would have paid income tax at 45% (£135,000). However, within the FIC, the corporation tax due is £73,750 (£50,000 at 19% plus £250,000 at 25%), resulting in a tax saving of £61,250.

Comparison with Personal Tax Rates

To illustrate the potential tax savings, let’s compare the effective tax rates on investment income for an individual versus an FIC:

  1. Dividend Income:
    • Individual (additional rate taxpayer): 39.35% tax
    • FIC: 25% corporation tax (on profits over £250,000)
  1. Interest Income:
    • Individual (additional rate taxpayer): 45% tax
    • FIC: 25% corporation tax (on profits over £250,000)
  1. Rental Income:
    • Individual (higher rate taxpayer): 40% tax
    • FIC: 25% corporation tax (on profits over £250,000)

It’s important to note that these savings are most significant when profits are retained within the FIC for reinvestment. If profits are distributed as dividends, the overall tax position may be less advantageous due to the additional layer of taxation on dividend income.

Explore our series on Family Investment Companies

  1. Family Investment Companies
  2. How do Family Investment Companies work?
  3. What are the tax implications of setting up a Family Investment Companies?
  4. Can a Family Investment Companies protect assets for future generations?
  5. How do Family Investment Companies differ from other types of trusts?
  6. What are the potential drawbacks or risks of Family Investment Companies?

Inheritance Tax (IHT)

FICs can be powerful tools for Inheritance Tax planning, offering several potential advantages:

Freezing Asset Values

When assets are transferred into an FIC, their value for IHT purposes is essentially “frozen” at the time of transfer. Any future growth in value occurs within the FIC and is therefore outside of the founder’s estate for IHT purposes.

For example:

Mr. and Mrs. Smith transfer £5 million worth of assets into their FIC in exchange for shares. Over the next 10 years, the value of these assets grows to £8 million. The £3 million growth is outside of their estate for IHT purposes, potentially saving £1.2 million in IHT (at the 40% rate).

Gradual Transfer of Wealth

FICs allow for the gradual transfer of wealth to the next generation through gifting of shares. This can be done using the annual gift allowance (currently £3,000 per donor) and potentially the normal expenditure out of income exemption.

For instance:

Each year, Mr. and Mrs. Smith gift shares worth £3,000 to each of their three children. Over 10 years, this allows them to transfer £180,000 worth of value out of their estate without any IHT implications.

Potential Pitfalls

It’s crucial to be aware of potential IHT pitfalls:

  1. Transfer of Value: The initial transfer of assets to the FIC could be a transfer of value for IHT purposes if full consideration is not received.
  2. Reservation of Benefit: If the founders continue to benefit from the assets transferred to the FIC, this could trigger the Gift with Reservation of Benefit rules.
  3. Pre-Owned Asset Tax (POAT): If founders continue to benefit from assets they’ve given away (via the FIC), they might be subject to an income tax charge under the POAT rules.

Capital Gains Tax (CGT)

Capital Gains Tax considerations come into play both when setting up an FIC and during its operation:

Initial Asset Transfer

Transferring assets into an FIC is a disposal for CGT purposes. This could trigger a CGT liability based on the increase in value since the asset was acquired. However, there are potential reliefs available:

  1. Hold-over Relief: This might be available if you’re transferring business assets or shares in a trading company.
  2. Business Asset Disposal Relief (formerly Entrepreneurs’ Relief): This could apply to transfers of shares in a personal trading company, reducing the CGT rate to 10% on gains up to £1 million.

For example:

Mrs. Jones transfers her buy-to-let property portfolio worth £2 million into an FIC. The properties have gained £500,000 in value since purchase. Without any reliefs, this could trigger a CGT bill of £140,000 (assuming she’s a higher rate taxpayer). However, if hold-over relief is available, this CGT could be deferred.

Ongoing Capital Gains

Once assets are within the FIC, any capital gains are subject to corporation tax rather than CGT. This can be advantageous as the corporation tax rate (even at 25%) is lower than the higher (28%) and basic (18%) CGT rates for residential property.

Moreover, companies can use indexation allowance to reduce their chargeable gains, although this has been frozen from January 2018.

Income Tax

While the FIC itself doesn’t pay income tax, there are income tax implications for shareholders:

Dividend Distributions

When the FIC distributes profits as dividends, these are taxable in the hands of the shareholders. The tax rates for 2023/24 are:

  • Basic rate taxpayers: 8.75%
  • Higher rate taxpayers: 33.75%
  • Additional rate taxpayers: 39.35%

However, each individual has a £1,000 dividend allowance (as of 2023/24), which can be utilized.

For example:

The Wilson FIC distributes £100,000 in dividends, split equally among Mr. and Mrs. Wilson and their two adult children. Each receives £25,000. Assuming they have no other dividend income, each would pay tax on £24,000 (after the £1,000 allowance). If they’re all basic rate taxpayers, the tax due would be £2,100 each.

Salary Payments

If family members work for the FIC, they can receive a salary. This is tax-deductible for the company but subject to income tax and National Insurance contributions for the recipient.

Careful planning of salary levels can make use of personal allowances and the NIC primary threshold, potentially resulting in tax-efficient remuneration.

Stamp Duty Land Tax (SDLT)

Transferring property into an FIC will typically incur SDLT. The rates are higher for companies than for individuals, and there’s an additional 3% surcharge for residential properties.

For example:

Transferring a residential property worth £500,000 into an FIC would incur SDLT of £30,000 (£15,000 standard rate plus £15,000 surcharge).

It’s worth noting that reliefs may be available in some circumstances, such as when multiple dwellings are transferred in a single transaction.

Annual Tax on Enveloped Dwellings (ATED)

If the FIC holds residential property valued at over £500,000, it may be liable for ATED. The annual charge ranges from £4,150 for properties valued between £500,000 and £1 million, up to £269,450 for properties over £20 million (2023/24 rates).

However, reliefs are available for properties used in property development businesses, let to unconnected persons, or part of a property trading business.

Value Added Tax (VAT)

If the FIC’s activities include VATable supplies (such as commercial property letting where the option to tax has been exercised), it may need to register for VAT. This brings both obligations (filing VAT returns, charging VAT) and potential benefits (reclaiming VAT on expenses).

Final Thoughts

While FICs can offer significant tax advantages, particularly in terms of corporation tax rates and IHT planning, they also come with complexities that require careful navigation. The interplay between corporation tax, income tax, CGT, IHT, SDLT, and potentially ATED and VAT requires holistic planning.

It’s crucial to consider the overall tax position of both the FIC and its shareholders, and to regularly review this as tax laws and family circumstances change. At TaxAgility, we specialize in helping families navigate these complexities, ensuring that your FIC structure remains tax-efficient and aligned with your overall wealth management goals.

Why not schedule a consultation with us to discuss how these tax implications would apply to your specific situation? We can provide a detailed analysis and help you determine whether an FIC could provide tax advantages for your family wealth management strategy