Family wealth planning: Trusts and Family Investment Companies

For many families, effective estate and inheritance tax planning is about more than reducing tax. It is also about passing wealth to the next generation in a controlled, protected and flexible way. Two structures often considered as part of long-term family wealth planning are trusts and Family Investment Companies (FICs). Each can provide valuable benefits, but they work in different ways and the right approach will depend on the family’s objectives, assets, tax position and need for future access to funds.

Both trusts and FICs can help families retain a degree of control while moving future growth outside the founder’s estate for inheritance tax purposes. However, there are important differences in how they are funded, taxed and administered.

Trust planning

A trust is a legal arrangement under which a donor, known as the settlor, transfers assets to trustees. The trustees then manage those assets for the benefit of the beneficiaries, in line with the terms of the trust. Trusts can be particularly useful where the family wants to protect assets, provide for future generations and retain a level of control over when and how beneficiaries receive value. We discuss the use of trusts further here.

Family Investment Company (FIC) planning

A FIC is a company established to hold and manage family wealth, with shares held by different family members or by family trusts. The company is managed by its directors, while economic value is held by the shareholders. FICs can be designed to give the founders control over investment decisions while allowing future growth to accrue for the wider family. We discuss the use of FICs further here.

How much can be invested?

Transfers into a discretionary trust are usually treated as chargeable lifetime transfers for inheritance tax purposes. An immediate inheritance tax charge at 20% can arise on the value transferred above the available nil rate band, currently up to £325,000 for an individual or £650,000 for a couple.

By contrast, there is no equivalent inheritance tax limit on the amount that can be invested through a FIC as there is no limit to how much founders can lend to the FIC as an IOU. This can make FICs attractive where the family wishes to transfer or earmark a larger pool of assets for long-term family investment. In time to come, the founders can gift the IOU (or a proportion of the IOU) to their children for IHT mitigation. Depending on the shareholding structure of the FIC, the majority of the future growth of the FIC can sit outside of the founders’ estate for effective IHT mitigation.

Tax treatment of income and growth

A key difference is the way income is taxed. Trust income is generally subject to income tax at the trust rate of 45%, whereas a FIC is usually subject to corporation tax on its profits. For a close investment holding company, the main rate of corporation tax is 25%. If the FIC invests in a basket of FTSE 100 shares, then the dividend income from these UK listed investments will be received by the FIC tax-free. This difference in tax rates can allow more income to be retained and reinvested within the FIC over time.

Access to funds and gifts with reservation of benefit

For inheritance tax planning to be effective, a settlor who transfers assets into a discretionary trust will need to be excluded from benefiting from those assets. This can be a drawback if the founders later need access to funds, for example to support retirement cashflow.

A FIC can offer more flexibility. Founders may retain a limited class of shares, enabling dividends to be paid on that class where appropriate. If the founders initially fund the FIC by way of loan, repayments of that loan can also provide a tax-efficient way to extract funds from the company, subject to the structure being implemented correctly.

Ongoing compliance and administration

A discretionary trust can be subject to periodic 10-year inheritance tax charges, exit charges when capital leaves the trust and ongoing reporting obligations.

A FIC also has ongoing compliance requirements, including company accounts, Companies House filings and corporation tax returns. For some families, however, the company framework may be easier to understand and administer than a trust, particularly where the family is already familiar with corporate structures.

Using trusts and FICs together

In many cases, the most effective planning will not be a choice between a trust and a FIC, but a carefully designed structure that uses both. A trust can hold shares for future generations, while the FIC provides the investment vehicle through which wealth is managed and grown. The key benefits being:

• The founders can retain control by acting as directors of the FIC, trustees of the trust and, where appropriate, holders of a limited share class.
• Different classes of shares can provide flexibility over dividend payments between family members or trusts, subject to the company’s articles and tax advice.
• A small retained shareholding may attract a minority discount for inheritance tax valuation purposes, depending on the facts and valuation advice.
• Founders can fund the FIC by way of loan and receive tax-free loan repayments over time, helping to support future cashflow needs.
• A trust can hold shares for minor children, grandchildren or future generations, supporting longer-term succession planning across the family.
• Dividend payments to a trust may help fund family objectives, such as education costs, where the structure is implemented and operated correctly.
• Where a FIC borrows to acquire investment assets, interest costs may be deductible against relevant profits, subject to the usual tax rules and restrictions.

There is no single answer that will suit every family. Trusts, FICs and hybrid structures all need to be considered in the context of the family’s wider commercial, personal and tax objectives.

If you would like to discuss how these structures could work for you, please contact us.