The following article is an excerpt taken from the report Sharing Wealth Using Family Investment Companies. Save 40% Today.
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In addition to family members subscribing for shares personally, shares in the FIC could also be subscribed for by, or gifted to, a family trust. While this has tax and protection advantages, it may also be a means by which shares can be held for minor children and family groups.
Note that the settlements legislation (referred to in more detail at section 5 above) would apply where a founder gifted shares to their minor children, or to a trust for their benefit, such that any income arising would be taxable on the founder. It would be possible to park shares into trust for the benefit of children once they reach majority, or for grandchildren or remoter issue.
A gift of assets to a discretionary trust is a chargeable lifetime transfer (CLT) for IHT purposes. This means that there is an immediate IHT charge of 20% on the value of the gift in excess of any available nil-rate band (currently £325,000). The available nil-rate band will be £325,000 less any chargeable transfers, i.e., gifts to other trusts, made in the seven years which precede the establishment of the trust. However, on incorporation, the value of FIC shares (or the amount required to subscribe for them) is minimal, meaning that the shares can be transferred into trust now with no IHT implications, and the value of the shares will grow while the assets are in trust. If it were decided to transfer shares into trust at a later point, when the FIC shares have acquired value, then IHT might again be in point.
Similarly, the default position is that a gift to a discretionary trust is a disposal deemed to take place at market value for CGT purposes. A CGT charge would be calculated on the deemed gain, being the market value of the shares at the time of the gift, less the price initially paid for the shares (and any associated costs of acquisition or disposal). Again, if the FIC shares are transferred while of no value, then no gain can arise.
If shares holding value were transferred into trust, however, any gain arising on a gift to a discretionary trust can normally be held over and deferred to a future disposal date in any case. This would mean that no CGT charge arises on the transfer of the shares into trust, and the trust instead inherits the settlor’s, i.e., the founder’s, tax base cost, and is chargeable on the gain when it sells the shares.
Once the FIC shares are in trust, the value becomes subject to IHT at trust rates rather than at 40% rates each time there is a death and assets pass from one generation to another, which over time can represent substantial tax savings.
Tax implications for a trust
Future ten-year charge
A trust would be subject to ten-year IHT charges in respect of the unsheltered value of the shares held in future years, subject to any £325,000 nil-rate band.
Ten-year charges are calculated based on the value of the trust’s chargeable assets at the date of the ten-year anniversary. The tax calculation is complex but is broadly charged at a maximum of 6% of the gross value above the nil-rate band. Again, the value of the shares in the FIC will be affected by the growth in the assets invested within the FIC, as well as how much of the loan balance has been repaid.
Income tax
Discretionary trustees are liable to income tax at additional rates of tax. Currently, trustees pay 39.35% tax on dividend income and 45% tax on other types of income. The first £500 of income may be taxable at lower rates, although this amount is similarly reduced by the number of trusts created as for the CGT allowance.
The trustees also have an attached tax credit of 45% on income distributed by the trust, which will be repayable to beneficiaries to the extent that it exceeds the tax due on that income.
However, given the founder would (likely) retain control of the FIC shares and would therefore ultimately control the flow of dividends into trust, it is likely that dividends would only be paid by the FIC if they were intended to be distributed from the trust to the beneficiaries. This could be of significant benefit if paying income out to minor beneficiaries (e.g., grandchildren, as minor children would give rise to a tax charge on the parent) and utilising their allowances and lower-rate bands. The trustees would be liable to pay 45% tax on these sums to ‘frank’ the distribution to the beneficiaries. Any sums retained in the trust would only be liable at dividend (39.35%) as appropriate. It may be possible to insert revocable life interest entitlements into a trust to streamline the income tax process.
Other considerations
The main reason for using a trust in this situation would be the protection it offers, not only as regards sheltering assets that are increasing in value from IHT for future generations, but also in preserving the wealth within the family. While articles and shareholder agreements can be drafted such that FIC shares cannot pass out of the family, this does not protect the value attributable to those shares in case of divorce, for example. If correctly structured, a trust can offer protection of the shares and the family wealth on a divorce as no one individual would have the right to the underlying assets (i.e., the FIC shares) held by the trust. If the shares were held personally by family members, their potential ex-spouses would be entitled to half of the value of the shares, even if this were to be satisfied from other assets in the joint estate. Nevertheless, family lawyers would always recommend pre- and post-nuptial agreements for added peace of mind.
Similarly, shares held in the trust would effectively remain in the family as long as the trustees choose to retain them within the trust; there would be no risk of the shares being disposed of, as might be the case if held personally by family members.
Example 8: Settling FIC shares into trust
Millie establishes a discretionary trust for her grandchildren and the trustees subscribe for a small number of ordinary shares in a newly formed FIC. Millie does not hold any shares personally, but controls the shares held by the trust as she is a trustee alongside her wife. On day one, the shares are of nominal value and there is no IHT or CGT consequence to the subscription, and the gift into trust is minimal.
Over time, the investment portfolio grows and the value attributable to those trustee-held shares increases. That growth is held inside the trust and therefore outside Millie’s estate on death. The trustees will remain subject to periodic trust charges, including the 10-year IHT charge where applicable, but the arrangement can prevent successive deaths triggering 40% IHT on the same appreciation.
