ViewPoint

UK family investment companies get the OK from the taxman

The UK tax authorities (HMRC) now considers that family investment companies (FICs) are not devices associated with tax avoidance.  So, might one be suitable for you?

HMRC have closed their FIC Unit – set up in 2019 to investigate tax avoidance connected with FIC structures – after it concluded there is no link between the use of FICs and non-compliant behaviour by taxpayers. HMRC’s conclusions will no doubt increase the attractiveness of FICs as one of the options for taxpayers’ succession planning and so it seems timely to remind ourselves why FICs offer planning advantages.

What is a FIC?

A FIC is a company limited by shares set up by members of the senior generation often for the main purpose of passing wealth and investments to the younger generations. The FIC would be incorporated in the UK or as a non-UK incorporated company that is “managed and controlled” in the UK.  As with all limited companies, the FIC is governed by the combination of (public) articles of association and a (private) shareholders’ agreement.

Why use one? 

Passing on value

The initial shareholders, the senior generation, can gift shares with material capital value to the younger generation and so pass value from the estate of the senior generation to the estate of the younger generation.  This can be achieved with some flexibility where a FIC has different share classes: different rights may attach to shares with the result that a particular share class may have a relatively high economic or capital value compared to another share class.    

Having said that FICs are a structure that can be used to pass on value, they also allow the senior generation some access to liquidity.  FICs are typically funded by a loan from the senior generation who can receive loan repayments which should not be taxable.  As shareholders, the senior generation may also be able to access a dividend stream, assuming their shares carry such rights, on which they will be subject to tax.

Retaining control

Issuing different classes of shares enables the senior generation to retain control over the assets while passing the economic rights over the assets to the younger generation. The senior generation are typically appointed as directors and may also hold the shares with the majority of the voting rights whether through the rights of a particular share class, or simply by the proportion of their shareholding. This allows them to retain key powers concerning decision making, for example, declaring dividends. The younger generations’ shares would typically have lesser or no voting power. 

Taking advantage of relatively low UK corporation tax rates

FICs are subject to corporation tax on their profits the UK’s headline 19% corporation tax (25% from the 2023 financial year), but this still compares favourably with rates applied to individuals on income and gains (applied at their marginal rate up of to 45% and 20 or 28% respectively). FICs also benefit from the UK’s dividend exemption regime under which most dividends paid to a FIC will be tax-free provided that the payor company is resident in the UK or a country that has a qualifying double taxation treaty. This tax treatment makes FICs particularly valuable vehicles for those looking to pass down income-generating investment assets and portfolios.

So, why not?

The above benefits must be weighed against the “costs” associated with accessing the return generated by the FIC.  It is tax-efficient to roll up income and gains in the FIC and pay corporation tax, but if a shareholder needs to obtain liquidity from the FIC and has no loan to call in, he will need to receive a dividend. While a UK resident shareholder qualifies for £2,000 of annual tax-free allowance, the highest marginal rate of tax on dividends is currently 38.1%, rising to 39.35% from 6 April 2022.  Given the profit comprising these dividends has already been taxed at the company level, this further layer of tax to access the dividends means a FIC is unlikely to be a suitable structure where shareholders would require regular dividend payments (although steps can be taken to provide alternatives to meet the beneficiary’s need without the use of dividends if required). 

 

Family limited partnerships (FLPs) revisited

The family limited partnership (‘FLP’) is a structure available to families for passing on wealth to the next generation. 

What is a FLP?

A FLP is a limited partnership formed of a general partner (‘GP’) who manages and controls the partnership, and limited partners (‘LPs’) who hold rights to the majority of the partnership’s economic value, but who have no say in management. Each partner is either a family member or entity, with the senior generation (or a limited liability company controlled by them) acting as the GP.  Usually, non-UK limited partnerships are used as the UK statute relating to limited partnerships is relatively restrictive compared to many offshore jurisdictions.

Why use one?

Passing on value

Typically the FLP is created by the senior generation contributing value and taking the initial LP interests, before transferring some or all of their LP interests to the younger generation.  The ownership of and access to the majority of the value within the FLP (represented in the LP interests) is separated from the control of and access to that value (which is maintained through the GP interest). Only the value is passed to the younger generation and, thus out of the estate of the senior generation.

Retaining control and flexibility

As mentioned, via their GP interest the senior generation retains control of the LP’s access to the value of their LPs interests.  As GP the senior generation also retains the ability to make strategic decisions on investing the assets and on the distribution policy for income and capital in respect of each LP (i.e. each member of the younger generation).  

Within this general structure, FLPs can be further tailored to build in the family’s preferences and requirements through personalising the partnership agreement (the partnership’s constitution, which is effectively a contract between the partners). This can include terms that protect the assets in the event of divorce and limit the transfer of LP interests by the children to third parties, thereby protecting the family’s wealth in the short and longer-term. The partnership agreement can also be amended at a later stage as required, for instance, to provide for the admission of new LPs as the family grows. 

What about tax?

Contributions into a FLP are no more costly from a tax perspective than outright gifts to the younger generation. Transferring assets into a FLP will be tax neutral, with the transfer of the LP interests to the younger generation becoming liable to an inheritance tax (‘IHT‘) charge should the donating partner die within seven years.  Unlike trusts, FLP are not subject to ten-yearly IHT charges.  Capital Gains Tax (‘CGT’) may be chargeable if the assets within the FLP stand at a gain when the LP interests are gifted. 

The FLP is treated as tax transparent and, as such, the partners are taxed on the income and gains relating to their share of the FLPs assets (at their marginal rates once their personal allowances have been applied). In this way the FLP is, again, no different in tax terms from the individuals holding the investments directly but, as mentioned, they do so within a control mechanism formalised in the partnership agreement.

This tax transparency means that FLPs are well suited to holding investments that in themselves, defer tax, such as insurance bonds, and/or realise gains that are taxed as relatively lower rates than income.  FLPs are less suited to holding real estate as, whilst technically possible, it can, amongst other things, present stamp duty land tax complications and mean the use of the property must be carefully managed to avoid unexpected tax inefficiencies.

Is there anything else to think about?

Technically FLPs are collective investment schemes which would usually mean they are subject to particular regulatory requirements policed by the UK Financial Conduct Authority (‘FCA’).  However, FLPs can be structured and operate in a way that means they can be exempted from FCA regulation. 

US connected families may also find our article “FLPs for US connected families in the UK” helpful.

To FLP or FIC: making the right choice for you 

While each family circumstance is different, we often find clients work through and weigh up a familiar mix of priorities and considerations. To help you begin to consider choosing between a FIC or FLP we set out below some of the key differences between the structures.

FICs FLPs
What? Private company used to hold family assets, whose shareholders and directors are family members. Limited partnership which holds family assets, whose partners are the family members
Why? Passing value from the senior generation to the younger generation so as to reduce senior generation’s exposure to inheritance tax, whilst access to the value held by the younger generation is subject to control mechanisms.
How?

(i) Value transfer

Senior generation funds the FIC and acquires shares.  Various share classes can be created – the rights impact the share values.  Certain (potentially valuable) shares are gifted to the next generation. Senior generation funds the FLP and acquires the general and limited partnership interests.  The latter, which comprise the majority of the economic value of the FLP, are gifted to the next generation.
How?

(ii) Control

Managed through (i) the formal structure of class rights, which determine voting and access to dividends; (ii) the shareholders agreement; (iii) senior generation being directors; and (iv) shareholder agreement Managed through the senior generation’s role as general partners.  Partnership agreement includes mechanisms for the general partner to manage partnership decision making and access to return of profits and capital.
Suitable asset classes
  • Income generating assets held in FIC have greatest tax efficiency but assets generating gains are not unsuitable.  
  • Useful where dividends from underlying companies can be received tax efficiently.
  • Well suited to pass down assets that defer tax and those which do not. 
  • Real estate can be held, although if residential property is invested this may lead to some tax leakage.
  • Better suited to assets that generate gains rather than those which primarily generate income, due to tax transparency of the structure.
  • Well suited to assets that defer tax such as OEICs, AUTs and insurance wrappers. 
  • Less suited to real estate due to challenges in maintaining the tax efficiency and practically in use of the property.
Access to liquidity/return Most appropriate where investment returns are rolled up at corporate level and do not ned to be accessed as dividends attract tax so access to liquidity comes at a “cost” (although shareholder loans may be used to provide liquidity in some circumstances). FLPs are tax transparent, i.e. profits on a partner’s interest in the FLP are taxed as if the partner owned the investment directly. Therefore the mechanisms providing for access to such profit do not result in further tax to access that liquidity.
Tax considerations on set up
  • If assets standing at a gain are contributed to the FIC, exposure to capital gains tax will arise at that point.
  • Gift of shares to younger generation are potentially taxable under inheritance tax rules.
Contribution of assets to partnership should be tax neutral, but the gift of partnership interests to younger generation are: (i) potentially taxable under inheritance tax rules and (ii) subject to capital gains tax if underlying investments are standing at a gain at point of gift.
Tax when accessing return Two layers: 
  • corporation tax (currently 19%; 25% from financial year 2022)
  • tax on dividends (highest marginal rate currently 38%; 39.35% from April 2022).
Tax transparent, so income and gains comprising the partner’s share of FLP profit are taxed at the personal tax rates of each partner.  Highest marginal rates currently 45% on income and 20/28% on gains (for dividends, see left).
International families Key tax benefit of a FIC results from the ability to roll up return at the relatively low UK corporation tax rate, therefore the FIC must be UK tax resident (causing the associated UK filing obligations) and dividends will in principle attract UK tax even if the shareholder is not UK tax resident.  Since the structure is tax transparent, the tax residence and the location of the underlying assets will determine the partners’ tax exposure.  So a non-UK FLP is suitable for families that are UK based as well as those with no UK nexus (where UK tax is not a driver).
Disclosure Corporation tax annual returns, records available on UK Companies House and if a UK incorporated FIC, persons with significant control appear on a UK register. Use of a non-UK limited partnership can mean there is very limited disclosure, but this is jurisdiction specific.  
Protection of assets Relatively effective in providing asset protection from creditors and in the event of divorce. Relatively effective in providing protection from creditors.  But a partnership interest could be a financial resource in the event of a relationship breakdown if regular payments have been made from a FLP.  
Flexibility Provides similar levels of flexibility to each other, which can be utilised to allow inclusion of new family members and/or changes to their rights in the structure.

Subscribe

You will need a Premium Plus Subscription to access this database.

Exclusive news, analysis and research on global family enterprise and private investment offices.

Access to the most comprehensive fully interactive database on global family offices, principal investment offices, and family enterprises.

Check Deal Data, Senior Staff, and New Analysis on more than 500 family/principal investment and holding groups

Already have an account? Login

Subscribe

You need at least a Premium Subscription to read this article.

The most comprehensive information service on the global family enterprise world, featuring exclusive news, analysis, research and data on global family enterprises, family offices, and private investment offices.

Premium

£299

per year

  • Exclusive reports, analysis and commentary
  • Exclusive access to family/private investment office deal information
  • Exclusive interviews with principals and senior management of family/investment offices
SUBSCRIBE NOW

Premium+

£399

per year

  • Access to All of Premium
  • Access to all of FamilyCapital Analytics, our interactive database with more than 500 detailed profiles of family investment groups

More Info

SUBSCRIBE NOW

Already have an account? Login

You've reached the end.

Continue reading free articles by registering as a Member.
Or choose a Premium Plan.

Membership

Free

  • Exclusive reports, analysis and commentary
REGISTER NOW

Premium

£299

per year

  • Exclusive reports, analysis and commentary
  • Exclusive access to family/private investment office deal information
  • Exclusive interviews with principals and senior management of family/investment offices
SUBSCRIBE NOW

Premium+

£399

per year

  • Access to All of Premium
  • Access to all of FamilyCapital Analytics, our interactive database with more than 500 detailed profiles of family investment groups

More Info

SUBSCRIBE NOW

Already have an account? Login

Leave a Reply