Family Investment Companies 2023

Family Investment Companies 2023

Today’s post is an update to a couple of articles I wrote back in 2019 on the topic of family investment companies.

The story so far

I should start by clarifying that this note is about any small unlisted investment company, not just one restricted to family members (though that seems to be the most common situation).

  • It could be owned by a group of friends or business associates, but the group is probably small in number (perhaps under the majority control of five or fewer people so that it qualifies as a close company).

I’ve never operated an investment company, though I have made investments through a trading company.

  • My corporate investing has yet to grow significantly enough to require a separate structure.

I have discussed setting up investment companies with other people on several occasions, but none has ever come up with the cash.

Why use a FIC?

As an outsider, the obvious (potential) attraction of a FIC would be some form of tax efficiency:

  • This won’t be Business Property Relief (as with AIM) since that exemption from IHT only applies to trading companies.
  • I believe there is a dividend tax exemption (as the issuing company has already paid tax on the distributed profits.

A second advantage is fractional ownership of large assets (like houses)

  • Ultimately, this is also about tax efficiency, since the key point would be lower taxes through gradual (annual) changes in the ownership structure.

A third plus is the potential for economies of scale:

  • Pooling assets could provide greater diversification benefits than individual company members could achieve on their own.
  • Truly diversified portfolios are hard to implement with less than £100K, but ten people each subscribing £10K would be able to achieve the same result.
  • There would also be savings from shared trading costs and subscriptions to sources of data and analysis (and attending conferences etc.)
Establishment
  1. The main point here is for founding members to make loans to the FIC where possible.
    • This allows for the return of the original capital without tax being due.
    • A loan might also come from retained profits in a parallel trading company.
    • These insider loans can offer competitive interest rates and little risk of being recalled.
  2. Assets could also be placed directly into the company in exchange for shares
    • Note that such transfers could crystallise capital gains liabilities and might attract stamp duty (in the case of property or shares).
  3. There may be multiple share classes with different voting rights (often used to distinguish between family generations).
    • This can allow parents to pass on assets with IHT efficiency but without losing control immediately.
    • Share classes may also have varying rights to dividends.
  4. A “family” member may be employed to operate the investment activities of the company and can be paid a salary as a regular employee.
    • And it should be possible to pay this fee to the parallel trading company (if it exists).
Tax
  1. The FIC would pay corporation tax on both income and capital gains.
    • The current rate is 25%, with a starter rate of 19% on profits below £50K, and transitional rates between £50K and £250K.
    • This is higher than the standard rate CGT (20%), but individuals have an annual £6K exemption from CGT (falling to £3K from April 2024).
    • The small profits rate does not apply to “close investment holding companies”, which probably means most FICs.
  2. Dividends are exempt but foreign dividends could be subject to withholding tax in the country of origin.
    • This is a “small company” exemption, which applies to companies with fewer than 50 employees, and turnover and assets below £10M.
  3. Since dividends above £1K pa (£500 pa from April 2024) are now taxable on the individual, this is not a practical/efficient way to distribute gains.
  4. Company members could sell shares up to their CGT limit if there are willing buyers (which might include the company itself).
    • Any individual buyers of shares would only be building up a bigger tax problem down the line.
  5. Tax relief on interest on borrowings is available.
    • This is an advantage relative to the tax treatment of individuals (as is the ability to offset the expenses of managing a share portfolio).
  6. Company borrowings could be used to leverage an investment portfolio.
    • Leverage can be used to counteract the taxation of profits to leave company members in the same position they would be outside an FIC.
  7. The formula to use is approximately 1/(1-n) formula, where n is the tax rate you are paying.
    • For the 19% starter rate of Corporation Tax, that works out at 1/81% = 123% gearing.
    • We also need to think about the interest rate at which we are borrowing (this will be much higher than when I wrote the first article four years ago).
    • If we assume 5% interest, we need 1/76% = 132% gearing.
    • If we assume 25% Corp Tax and 5% interest, we need 1/70% = 143% gearing.
  8. We can aim for a lower level of gearing if some of the company income/profits come from untaxed dividends from other (listed) companies.
    • You could also run hotter, with more leverage than needed to break even (but this would have been a better idea when borrowing rates were lower).
  9. There are also potential IHT advantages:
    • Any growth in the value of assets after they have been transferred to the FIC will be ignored for IHT purposes
    • Minority shareholdings in the FIC will benefit from a valuation discount due to the lack of control
See also:  Making a Will
Updates

Back in 2019, the main source of information on investment companies was Michael from Foxy Monkey.

  • Since then, Finimus (who used to write on his own blog, but now writes for Monevator) has written a couple of long articles on the subject.

Finimus has been running a FIC for 20 years, so he knows a lot about it.

  • The rest of today’s update is really a run-through of his articles to check that we haven’t missed anything or got anything wrong.

Finimus’ example FIC involves a £1M loan (from unsheltered cash) into the FIC, which is repaid over 20 years from the 5% dividends on the shares that the FIC invests in.

  • At the end of the 20 years, getting capital out of the FIC via a dividend results in the payment of all the dividend tax that has been saved along the way (assuming constant tax bands on the owner).

So the FIC offers dividend tax deferral, with the owner able to choose the timing of when he pays the tax.

  • Which means that you can wait until you are in a lower tax band.

There’s lots of other good stuff on brokers and bank accounts to use, and stocks to choose, but that’s it for strategy.

Conclusions

So nothing seems to have changed, and an FIC still seems to have marginal attractions for most people. The four use cases are:

  1. You have a lot of unsheltered cash/stocks outside your ISAs, SIPPs and VCTs
  2. You have a lot of cash in a trading company
  3. You want to pool assets with a group of friends/relatives
  4. You want to pass money down to your kids

None of those apply to me at present.

  • Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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IHT

Family Investment Companies 2023

by Mike Rawson time to read: 4 min