Family Investment Companies remain an effective estate planning tool despite HMRC attention

HMRC have said “The Family Investment Company team was established … in April 2019 to look at FICs and do a quantitative and qualitative review into any tax risks associated with them with a focus on inheritance tax implications. The team’s work is exploratory at this stage and as such, we would not like to share any more details.”

The unit has been in existence now for a year and to date HMRC are still not sharing any further details.  A budget has come and gone and no changes were announced that targeted the use of FICs.  

What are the inheritance tax implications of a FIC?

Families have been using FICs to help reduce their inheritance tax liability in a number of ways.

• First, by making gifts. When establishing a FIC, parents use cash to subscribe for shares in the company and the shares are given to children and grandchildren.  This is a straightforward gift.  If the parents survive seven years from the date of the gift, the value will fall out of their estates for inheritance tax purposes.  Gifting is an established way to reduce your inheritance tax exposure and the rules on gifts have been around for a long time. 
• Secondly, once a gift of the shares is made, the shares will grow in value hopefully as the FIC grows the value of its assets.  This growth is now outside of the parents’ estate, saving further inheritance tax.  This is the natural result of making a gift.
• Thirdly, unlike trusts, there is no inheritance tax payable when you fund a FIC and you do not pay inheritance tax every ten years or when capital comes out to shareholders (although other taxes will be payable).  This is again just a natural consequence of a company not being a trust (if appropriately structured) and being taxed differently. 
• Fourthly, shares owned by the children will be in their estates for inheritance tax purposes. But the method of valuing shares, established by legislation and case law over many years, means that the value of individual holdings, that represent a minority interest in the FIC, are likely to benefit from a discount. The discount means the shares are worth less than their proportionate share of the total company.  This discount, saves further inheritance tax.

The inheritance tax advantages of using a FIC come from established rules and do not rely on any loopholes in the legislation. Nor are the arrangements contrived in order to obtain these inheritance tax advantages.  So it is hard to see what aspects of the inheritance tax implications of using a FIC, HMRC can take offence to.  Perhaps that is why, after a year of their special unit looking at FICs, we have heard nothing.

Is a FIC a sophisticated legal instrument?

Not necessarily, a FIC is just a company. A company resident in the UK for tax purposes and listed at Companies House.  It can be very simple, with a single class of shares and straightforward constitutional documents. But a simple company does not offer the level of control, protection or flexibility that are also important concerns for families.  So in practice, a FIC will include many bespoke features including:

• Ensuring that the board of directors are able to maintain complete control over all practical decisions that need to be taken by the FIC to manage investments and determine when and how to distribute profits to shareholders.
• Restricting what shareholders can do with their shares, in particular preventing share sales and transfers to individuals outside of the family.
• Giving the directors flexibility to declare dividends at different times and for different amounts to each shareholder.
• Enabling the directors to force a transfer of shares if a shareholder breaches the rules or faces a financial claim, such as on divorce or bankruptcy.

These bespoke features may make a FIC a sophisticated legal instrument but tax planning is not the motive behind these features.

Will we see challenges or changes to FICs?

Challenges are likely.  We have seen evidence of FICs being used in combination with other planning strategies that overall are designed to achieve greater tax savings and can appear more contrived. As a result we are likely to see HMRC challenge some arrangements that involve the use of a FIC, just as we have seen in the past with tax planning schemes that involved trusts.

Changes are also expected. The ongoing tax treatment of a FIC is determined by the investment strategy and the rules applied are the same for all investment companies.  It now seems likely that HMRC will deem those rules to be too generous and the need to replenish public funds after the current crisis will only increase the likelihood for change. 

As to the nature of the changes we might see, our thoughts are as follows (in no particular order):

Conclusion

It was always likely that HMRC would start to look at the use of family investment companies, particularly given the recent increase in their popularity.  Does that mean they face an impossible headwind? We don’t think so.  As always, clients need to take proper advice on whether a FIC is the right vehicle for them and if so, how they should be structured.  That advice must now consider the potential changes that may come along to test whether or not a FIC will remain an appropriate vehicle. But the potential for change should not discourage the use of a FIC.  We have always promoted FICs on the basis that they are long term planning vehicles, lasting several decades and change to their tax treatment was always inevitable.  It is important not to forget the original objectives of protecting family capital and providing an income stream for future generations.  FICs will still deliver on these aims.  In our opinion, in the right circumstances FICs can and do play a really useful and effective role in a family’s estate planning and potential changes are unlikely to stop that.