Family investment companies (FICs) have become a popular choice, largely due to the absence of an entry charge and the lack of ongoing IHT charges under the relevant property regime. The other attraction is that clients tend to be familiar with limited companies as many entrepreneurs trade through that medium already.
With suitable guidance, a company can echo many of the hallmarks of a traditional Trust; directors stand in the shoes of Trustees and shareholders as the beneficiaries, allowing directors to manage the company assets on the shareholders’ behalf.
Furthermore, with suitable articles of association (the company rulebook) and a well-drafted shareholders agreement, directors can control the payments made to shareholders.
In addition to no upfront entry charges, due to the differing tax rate (FIC 19%, Discretionary Trust 45%), a FIC can enable wealth to be rolled up and the compounding effect of the different tax rates over time can be dramatic. In most circumstances dividends received by a FIC are not taxed.
Will this regime continue if we have a change of government?
A large part of the attraction to FICs is its ongoing tax efficiency due to the lower rate of tax on income and no tax on dividends. The current tax rate (19%), which is due to reduce in April 2020 to 17%, has not always been this low. In 2010, the main rate was 28%, so the current low rates may not last.
With the prospect of an imminent General Election, it is worth considering what impact a change of government might have.
While the Conservative party would likely make no changes, it being the brainchild of previous chancellors, Labour has previously announced they are committed to increasing corporation tax. In its 2017 manifesto, Labour stated it would look to increase the tax to 26%.
While a 26% rate is still favourable compared to a 45% headline rate in a Trust, the difference is further reduced when the secondary tax charges on distributions are considered.
The traditional Trust may lose out in a number of ways compared against a FIC; it can pay more income taxes and there can be entry tax charges and ongoing 10 yearly tax charges.
However in some circumstances the flexibility offered by a family Trust can mean it is still the right tool for the job.
When dealing with assets that are eligible for certain tax reliefs (such as family businesses), the entry charge and ongoing 10 yearly tax charges can be mitigated to eliminate many of the negatives.
For some clients, the right answer is often a combination of the two; a family investment company within which the wealth is invested but to enable benefits to be passed onto future generations; a number of the shares are placed into a family Trust.
So while the number of new Trusts may be falling, they still have much to offer the informed client and advisor.
The statistics show that just over 60,000 Trusts have income of £10,000 or less. With the current complexity of the UK tax system, the compliance costs for such Trusts are often a large proportion of their income. Given the increasing vulnerability of the youngest members of our society to online fraud, Trusts still have an important role to play. Is it time that the rules were overhauled to offer genuine simplicity? For example, such Trusts could be exempted from income tax to remove the need to report annually. However whenever any funds were distributed, they could then be taxed on the beneficiary at that time. This simplification would also allow HMRC to better target their limited resources on the more complex Trusts.
This was first published in FT Adviser in November 2019.