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HMRC's Secret "Tax Squad"!5th March 2020 Wills, Trusts & Estate Planning
According to recent press, HMRC have created a new unit designed to investigate the legal structure widely known as a “Family Investment Company” or “FIC” for short. Various articles have described this – somewhat sensationally – as “a secretive unit” or a “secret tax squad”. So what exactly is a FIC, why is it used, and should clients be worried?
A FIC is, in very simple terms, a corporate structure used for the primary purposes of holding assets or investments. A FIC is usually (but not always) a company limited by shares, and is almost always entirely owned within a particular family, and it is established with (usually) different share classes giving particular family members bespoke economic and voting rights.
At the outset, it is important to note that the use of a corporate structure to hold family or personal investments is not a new concept; for many decades, individuals have held significant wealth – including, commonly, portfolios of investment properties -within a corporate wrapper. However, since 2006, the use of FICs to structure family wealth has become increasingly popular, primarily as a means of control and protection whilst implementing tax planning opportunities.
Prior to March 2006, wealthy individuals would typically settle significant wealth into family trusts as a means to both mitigate against inheritance tax (“IHT”), and in order to protect the money or wealth gifted away. Assuming, for example, that an individual wished to give away £1m cash to his/her two children, prior to 22 March 2006 the individual had the following (typical, and well established) options:
- Give the £1m to his/her children equally (i.e. £500,000 each); or
- Settle the £1m into a trust for the benefit of the children.
Either option had the consequence that the individual would escape IHT on the £1m if he/she survived the gift or the settlement by seven years.
Option (1) was (and remains) undesirable, as it exposes the children to significant wealth without any control. Where the children are minors, they would have full and unfettered access to the capital at 18, and the money gifted was therefore not protected from the children’s financial immaturity. Similarly, the monies gifted were exposed to divorce, bankruptcy and other potential problems in the hands of the children.
Option (2), therefore, was commonly implemented. The terms of the trust would be that either the children would be given an “interest in possession” in the trust – broadly speaking a right to income, and usually if the children were over 25 – or alternatively an “accumulation and maintenance” trust would be used. These type of trusts were given preferential treatment by the tax legislation then in force, and offered a way of making gifts to children (and hence starting the seven year survival period going), but whilst maintaining control and protection over the monies in trust, as the children could not access capital without the authority of the Trustees.
The Finance Act of 2006 fundamentally changed the taxation of trusts, such that option (2) is no longer available. An individual now has the option to give away the cash to the children (i.e. option 1), or create a trust with assets up to £325,000. Except in very limited circumstances, settlement into trust of more than £325,000 results in a lifetime charge to IHT at a rate of 20%, and further IHT charges in the event of death within seven years.
Hence, an individual must choose between giving away more than £325,000, but with no control, or up to £325,000, with control.
The FIC: a method of preserving control
Against this backdrop, the use of FICs has increased substantially, as a means of giving away more than £325,000, but whilst maintaining control of the assets. In short, the FIC offers an opportunity to achieve a reasonable balance between IHT mitigation and control.
There are many possible structures, and much is dependent upon an individual’s circumstances, but typically the structure involves making a gift of cash (used to subscribe for shares) or of the shares in the FIC themselves, to the next generation. These are gifts of value which trigger the seven year survival period for IHT purposes for the individuals who are implementing the IHT mitigation. Importantly, however, the cash used to subscribe for the shares is held by the FIC and subject to the FIC’s constitutional documents which prevent easy access to capital for the younger generation.
Control of the FIC can be kept away from the children by the issue of different share classes, or by the use of trusts. Hence, wealth can be passed to the next generation, in excess of £325,000, without a loss of control and without a 20% up front charge to tax.
There are other tax benefits to the use of a FIC (i.e. the attractive rate of corporation tax at the present time), but there are also drawbacks (i.e. a layer of double taxation – investment growth suffers corporation tax, and then also income tax, as profits must be extracted by way of dividend to the shareholders). There are also IHT complexities which must be fully explored on establishment of the structure.
HMRC’s Tax Squad!
The Financial Times reported that HMRC’s new unit was established in April 2019, “amid growing concern about inequality and the perception that the wealthy avoid taxes by using sophisticated legal instruments”. In our view, the FIC is not a “sophisticated legal instrument” in the context suggested: it is merely a limited company, used by a family to hold investments. Companies have been used in this context for many decades, and there is nothing particularly novel or aggressive about their use as wealth preservation or protection vehicles.
HMRC went further and, in a statement to the Financial Times, stated that the unit was established to “do a quantitative and qualitative review into any tax risks associated with [FICs] with a focus on inheritance tax implications”. HMRC went on to say that the team’s work was “exploratory at this stage”.
In our view, there is no cause for immediate alarm here. HMRC was always likely to review the use of FICs, given their growing popularity, and there is at present no suggestion of material change to the tax legislation which would negatively impact on this type of planning. We do not believe that the use of the FIC is akin to other, more aggressive, tax planning strategies that have been implemented (sometimes unsuccessfully) in years gone by, and in any event it is difficult to see how HMRC might argue that the planning which has been implemented is somehow ineffective. We would always advise clients to adopt a pragmatic approach to the establishment of a FIC, which would not include particularly complex or convoluted funding or shareholding structures which might be more vulnerable to challenge.
There are, of course, options for Parliament to attack this type of planning, perhaps with the implementation of new tax rates or regulations which are designed to make the FIC structure less attractive (i.e. by increasing the corporation tax rate for investment companies). At present, there seems no immediate likelihood of change, and there are other more likely candidates for tax change which have been well documented (i.e. an attack on Entrepreneurs’ Relief for Capital Gains Tax).
We do not believe that FICs are likely to be open to challenge on the basis of illegality or tax inefficiency, but that it is possible that a change to the tax regime could be adopted to make the structure less attractive. Nevertheless, FICs remain a useful structure, not only to mitigate against tax, but also to protect family wealth and allow access to money slowly to the next generation. In our view, they remain (and are likely to remain) a sensible option for wealthy families.
If you would like to discuss this article further, or indeed explore the use of a FIC for yourself or a client, please do not hesitate to contact Joe Cobb of JMW Solicitors on firstname.lastname@example.org, or 0161 838 2615.