What is the issue?
Her Majesty’s Revenue and Customs has recently closed down the special unit tasked with the investigation of family investment companies (FICs) and broadly given them a clean bill of health.
What does it mean for me?
Those who have been anxious about utilising FICs can now cautiously proceed with an exploration of their usefulness in achieving the objectives of the family.
What can I take away?
FICs are a useful vehicle in any succession planning strategy; however, the tax issues involved are complex so detailed advice should be sought.
Her Majesty’s Revenue and Customs (HMRC) has recently released a report from a dedicated compliance team tasked with looking at the strategy and mechanics of family investment companies (FICs). HMRC has said that it now has a better understanding of who uses FICs and found no evidence of a correlation with non‑compliant behaviour.
Given taxpayers effectively have the green light to proceed, business as usual, in utilising these structures where appropriate, this article considers the practical set‑up and relevant tax considerations for FICs. There is inevitably a tax cost to profit extraction, so it is more common to use the structure for investment roll‑up purposes. It is also worth making reference to the continued use of the trust as a family tax and succession planning vehicle.
There are considerable tax advantages to sheltering the profits of a family enterprise inside the savings box of a corporate vehicle. The relatively low corporation tax rate allows profits to accumulate for the ultimate benefit of future generations.
An FIC can be established with the desired proportions of shareholdings allocated among the family ab initio or, alternatively, by later injecting cash or assets into a company and creating different types of shares for different family members that carry different rights to dividends, entitlement to vote and entitlement to capital on winding up (commonly referred to as alphabet shares). In most cases, ordinary shares are used, but it is possible to issue preference shares that carry priority rights to dividends.
The matriarch or patriarch will want to retain control and will therefore be named directors and possibly preferential shareholders, perhaps retaining voting rights (caution is recommended), but will likely limit their rights to underlying capital for succession planning reasons. Other shares may be gifted to family members when the company is set up with little or low value or, if gifted later, the value of the money or property transferred (as long as no beneficial interest is retained) will fall outside of the parent’s estate for inheritance tax (IHT) purposes after seven years.
In the event family members are aged under 18 and have no legal capacity to hold shares, a simple nominee declaration or bare trust can be used to hold the legal title without affecting the underlying beneficial interests.
Profits are commonly extracted as dividends and taxable at the normal dividend rate of the recipient. The directors are entirely at liberty to pay or legally waive declared dividends in accordance with how all members of the family (i.e., the shareholders) wish to direct.
During a dividend waiver, which must be done by deed and before entitlement arises (i.e., before payment in the case of an interim dividend or resolution and declaration for a final dividend), a person waiving a dividend could, prima facie, be making a transfer of value by the omission to exercise a right under s.3(3) of the Inheritance Tax Act 1984 (the Act). However, s.15 of the Act explicitly states that a person who waives any dividend on shares within 12 months of a declaration does not, per se, make a transfer of value.
When looking at income tax on profit extraction via dividends, one needs to be wary of s.620 of the Income Tax (Trading and Other Income) Act 2005 (the settlements legislation), which is intended to prevent a settlor from gaining an income tax advantage by making arrangements that divert income to a person who is liable to income tax at a lower rate. Where the settlements legislation applies to a dividend waiver, all the income waived is treated as that of the settlor. This legislation applies in certain circumstances for gifts between spouses or to a minor child as the settlor is treated as retaining an interest in an asset or income deriving from it.
These rules (now commonly referred to as ‘income shifting’) were debated in the House of Lords in the case of Jones v Garnett (Arctic Systems)  UKHL 35. In this case, Mr and Mrs Jones owned equal shares in the family company. Mr Jones was the fee‑earner and Mrs Jones did the administration. They both took a small salary and a significant dividend. HMRC argued that the anti‑avoidance rules relating to settlements applied to the dividends paid to Mrs Jones to treat the dividends as income of Mr Jones.
Lord Hoffman commented that this arrangement was no normal commercial transaction between adults at arm’s length, but instead it was ‘natural love and affection’ that provided the consideration for the benefit he intended to confer upon his wife.
The House of Lords ultimately dismissed the HMRC appeal on a technical argument that the rules did not apply on the basis that, in this case, the ordinary shares were not substantially a right to income. This was an important distinction and, following this case, most shareholdings issued in this context involve shares that also carry full voting and capital rights.
In the context of a family company, although there might be a s.620 settlement, the legislation at s.624 would not operate to tax the settlor on income paid out to either a child who is no longer a minor or to a grandchild or any family member who it could not be said would result in the settlor retaining an interest in the income.
The mechanics of how a dividend is declared is of paramount importance in navigating the settlements legislation and ensuring that there is no income diversion. If it makes no difference to the amount received by the recipient shareholder that the other party waived their right to take a dividend, then it cannot be said that there has been any diversion of income. If, however, a global dividend sum is declared and then divided among the family member shareholders, and certain members waive their rights and the result is that some members consequently benefit from an increased dividend, then this is a different story. There need to be sufficient distributable reserves to cover the dividend payment as well as the waiver in this latter scenario, so it can truly be said that there has been no diversion of income, as it would not make any difference to anyone if the shareholder forgoes their right to a dividend or not.
Capital gains tax
If the market value of shares gifted exceeds the original cost, there will, prima facie, be a gain chargeable to capital gains tax (CGT). In the context of a family company, it may be possible to utilise exemptions or reliefs to mitigate this charge. Any gift between spouses will be exempt as the transfer is deemed to take place at no gain, no loss; the spouse simply inherits the base cost of the donor. Gifts into a trust can usually benefit from holdover relief from CGT on the basis that a lifetime IHT arises; however, this exemption will not work for transfers into a company.
Transferring immovable property into a company makes matters more complicated as this could potentially result in CGT and stamp duty land tax.
A trust as an alternative
There has been a large decline in the use of trusts in the context of family tax planning, following the enactment of the Finance Act 2006 and the introduction of the 20 per cent lifetime IHT charge on any amount transferred into a trust (absent any relief and if in excess of the GBP325,000 nil‑rate band). In addition, periodic charges (every ten years, tax is levied on the value of the trust property at circa 6 per cent) and exit charges (when property leaves a trust) apply to relevant property.
Notwithstanding these tax charges, a discretionary trust might still be appropriate if the aim is to hold shares in order to benefit beneficiaries at some future time and possibly on a discretionary basis; to prevent beneficiaries becoming entitled upon reaching majority; or to protect the shares from errant spouses.
Often, parents are reluctant to bestow substantial benefits on their children, but look more favourably on funds extracted to educate grandchildren, so the flexibility of using alphabet shares to direct profits where desired is attractive. Nevertheless, it is a tricky area to navigate, riddled with tax traps, so proper advice should be taken at all times.
The End is Nigh for the Non-Dom Regime
Published in ThoughtLeaders4 Private Client Magazine, Helen McGhee expert analysis of the current state of non-dom tax regime and it's future.
HMRC Makes Changes to COP9
On 14 June 2023, HMRC published a substantially rewritten Code of Practice 9 (“COP9”). Helen McGhee and Megan Durnford set out the key changes implemented as a result of this publication.
Pandora Papers: HMRC issues nudge letters
The Pandora Papers leak of almost 12m documents back in 2021 purportedly exposed the secret accounts and dealings (including potential tax evasion/ avoidance and money laundering) of 35 world leaders (including the late HM Elizabeth II), as well as many politicians and billionaires. The data was obtained by the International Consortium of Investigative Journalists in Washington DC and led to one of the biggest ever global financial investigations.
Increased Investment in Personal Tax Compliance in the UK (Published in Thought Leaders 4 Private Client)
Advances in technology and increased international fiscal co-operation have made global personal tax compliance initiatives pop up in abundance in recent years. To compound the issue, the Russian invasion of Ukraine and the corresponding economic fallout prompted domestic governments to increase transparency in relation to investments held by wealthy foreign individuals (with a focus on oligarchs).
In the UK, in the context of the cost-of-living crisis, public opinion certainly seems to be in favour of increased accountability for high-net-worth individuals (eg, on 9 October 2022, 63% of Britons surveyed thought that “the rich are not paying enough and their taxes should be increased”).1
HMRC is one of the most sophisticated tax collection authorities in the world and the department is making significant investments in technology in the field of compliance work; they are well placed to take advantage of new international efforts to increase tax compliance, particularly considering the already extensive network of 130 bilateral tax treaties in the UK (the largest in the world).2 The UK was also a founding member of the OECD’s Joint International Taskforce on Shared Intelligence and Collaboration (JITSIC) forum.
This article discusses the main developments in support of the increased focus on international transparency and personal tax compliance in the UK. There are other international fiscal initiatives, particularly in the field of corporate taxation, but such initiatives are beyond the scope of this article.
It should be noted that a somewhat piecemeal approach, with constant tinkering makes compliance difficult for the taxpayer and is often criticised for lacking the certainty that a stable tax system needs to thrive.
This article was first published with ThoughtLeaders4 Private Client Magazine
Tax-Related Measures in the Autumn Statement 2022
On 17 November 2022, the Rt Hon Jeremy Hunt MP, the Chancellor of the Exchequer, unveiled the contents of the Autumn Budget 2022. This comes after the International Monetary Fund (IMF) published its world economic forecast on 11 October 2022. The IMF expects the British economy to grow 3.6% in 2022 and 0.3% in 2023. Other major developed economies are also expected to stagnate next year, namely Spain (1.2%), the US (1.0%), France (0.7%), Italy (-0.2%) and Germany (-0.3%).
This note focuses on tax measures included as part of that statement.