Since the time of Henry VIII, trusts have been used to protect assets from the whims of wayward children, ex-spouses, creditors, and tax collectors. And although they remain a useful way of separating legal and beneficial ownership, the tightening of regulations from 2006 and the enthusiasm of HMRC and local governments to claw back trust capital (for the latter, this occurs when the trust has obviously been established to avoid paying care costs) has made people increasingly wary of their usefulness. This has resulted in the rise in popularity of family investment companies (FICs), which also provide many advantages.
Which option is right for you and your family? Let us explain the pros and cons of each alternative and how they can work together to provide the ultimate wealth-protection solution.
What is the difference between a trust and a family investment company?
A trust is a legal vehicle that allows you (the settlor) to transfer assets into a trust for the benefit of others (known as beneficiaries). Trustees, who are appointed by the settlor are responsible for administering the trust.
An FIC, on the other hand, is a company established to hold a family’s investments, for example, investment property or share portfolios). Parents or grandparents typically fund FICs by making loans or subscribing for shares, then gifting the shares and loans to their children, grandchildren, and other family members to allow them to receive future benefits.
What advantages do FICs have over trusts?
One of the most attractive attributes of an FIC is that you, as the person who sets it up, can retain control over the company’s assets. This is achieved by granting yourself voting rights without rights to the capital. You can also make yourself a director of the company and entrench and enhance your control through the company’s Articles of Association and by creating a Shareholders’ Agreement. After seven years, the transferred assets would fall outside of your estate for inheritance tax (IHT) purposes. A trust does not provide for such flexibility, once assets are placed into a trust they are managed by the trustees.
Another advantage of an FIC comes from the amount of capital which can be protected from future IHT. Following the 2006 reforms, almost all gifts transferred into a trust are chargeable lifetime transfers. This means that the maximum amount that can be settled by one settlor is equal to the nil-rate band (currently £325,000 or £650,000 if both spouses can make the gift). Amounts above the nil-rate-band are taxed at 20 per cent. Various tax reliefs such as business property relief and agricultural property relief can increase this cap, but this can add to the complexity and cost of setting up a trust. On the flip side, if an asset is gifted to an FIC it is automatically a potentially exempt transfer (PET), therefore outside the taxable lifetime transfer rules that apply to a trust so long as the parent or grandparent survives for seven years after making the gift. If the FIC is funded by a loan, no gift exists because the value of your estate remains constant.
Finally, there is the tax advantage provided by FICs. An FIC is taxed in the same way as any UK resident investment company. Profits, which are made up of income and gains, are subject to corporation tax (currently 19 per cent). UK and non-UK source dividends and other distributions received by the FIC are likely to fall within an exemption from corporation tax unless they are caught by particular anti-avoidance rules. FICs, therefore, gain from a gross roll-up of dividend income, making investing in equities a profitable strategy.
Trusts pay income tax at 45 per cent or 38.1 per cent on dividend income. Furthermore, they are subject to periodic tenth anniversary charges at a maximum of six per cent.
Do trusts provide any benefits over an FIC?
A major drawback of FICs is that they cannot aid people who have yet to be born. A trust, however, can benefit future generations for 125 years. In addition, although trusts must be registered with HMRC, the arrangements remain private. If an FIC is registered as a limited liability company, its accounts and set-up become publicly available.
Which option is right for you?
Generally, a discretionary trust is preferable for:
FICs work well in situations where:
When engaging in wealth planning it is imperative to talk with a professional private client solicitor who can explain the options available and advise you on the right choice for your family. Once you have decided on the best solution, your solicitor can create a robust structure that can survive any future challenges.