Should you be worried about HMRC crack down on FICs?

Published on
4 min read

It has been revealed that HM Revenue & Customs (HMRC) has set up a secretive unit to investigate the growing use of family investment companies (FICs) to reduce inheritance tax.

The article in the Financial Times suggested HMRC was concerned about inequality and the perception that the wealthy avoid taxes by using “sophisticated legal instruments”.

In a statement HMRC said “The Family Investment Company team was established … in April 2019 to look at FICs and do a quantitative and qualitative review into any tax risks associated with them with a focus on inheritance tax implications. The team’s work is exploratory at this stage and, as such, we would not like to share any more details.”

We are also aware through our network of accountants that HMRC has been asking routine questions about the structure and funding of established FICs.

Should we be concerned about FICs?

In our view no. Setting up a company to hold family investments cannot be regarded as “exploiting a loophole”. The inheritance tax saving comes from individuals making gifts of either cash - used to subscribe for shares - or of shares themselves. The gifts are genuine and this is an established method of reducing your estate for inheritance tax purposes. It is not exploiting a loophole.

The second inheritance tax benefit that arises from a FIC, is the benefit of a minority interest when valuing the shares held by shareholders. This benefit comes from well-established rules on how to value company shares. Nothing contrived is needed to benefit from these rules.

With regard to the ongoing tax treatment of a FIC, this is determined by the investment strategy and the rules applied are the same for all. If HMRC deem those rules too generous, which given the existence of the special unit, now seems likely, then we may see change.

As to the nature of the changes we might see, our thoughts are as follows (in no particular order):

Possible change Mills & Reeve view
Imposing a tax charge on a lifetime gift. The recent proposal for the reform of inheritance tax set out in an all-party parliamentary group report in January 2020 recommends this change for all gifts along with other sweeping changes to inheritance tax This potential tax charge may put some people off making lifetime gifts but there will still be benefits in moving wealth on to the next generation sooner than later, so that the growth is outside of your estate.
Challenges to the value of shares that only have voting rights. We are aware of HMRC already raising challenges that such shares have a material value and this may give rise to some unexpected tax charges.  We have always taken a different approach with our FICs that avoids this risk.
Changes in the related property rules for inheritance tax purposes to include all shares owned by family members rather than just spouses to reduce the benefit of a minority interest discount Currently family members benefit from their shareholding being valued on the basis it is a minority interest for inheritance tax purposes.  If it was necessary to take account of other family held shares, this discount could be lost.
Increase in the corporation tax rate for investment companies. This would be a very easy change to make. The current rate is 19% which is very low, especially compared to a trust which pays tax at 45% although shareholders still have to pay further tax to extract the profits and the effect of the two rates is already higher than for trusts.
Removal or restriction of the exemption for the taxation of dividends received by an investment company. Currently a FIC receiving dividend income will benefit from an exemption such that no corporation tax is charged on that income. If introduced, FICs may be able to reduce the impact of this by changing their investment structure to reduce the income generated.
Reconsidering the rules regarding taxing undistributed profits on shareholders. This proposal was floated by HMRC a while ago but later dropped. The idea may come back. It may be possible to reduce the impact by adopting an alternative investment approach.
Changes to the treatment of interest free loans to a company. This has always been expected and we have seen evidence of HMRC raising challenges already using existing anti-avoidance legislation.

Conclusion

It was always likely that HMRC would start to look at the use of family investment companies, particularly given the recent increase in their popularity. Some structures may be vulnerable to a successful challenge by HMRC as a result of the use of complex funding arrangements or creative share structures.

But the vast majority of FICs that we have seen are not, in our view, open to challenge based on their existing structure. What is more likely is a change in the taxation of FICs, which may make them less attractive, although it should not be forgotten that there are many non-tax driven benefits of a FIC, such as the ability to control investments, the transfer of interests and the payment of income or capital. This will mean FICs continue to be an appropriate structure for families to consider as part of their overall wealth strategy. 

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