How are FICs funded and what are the tax implications?
As part of our new series on Family Investment Companies - commonly known as FICs, today, we delve into how FICs are funded by cash, with practical options for private clients.
From a corporate and accounting perspective it is necessary for any assets or cash contributed into the FIC structure to be properly categorised so that there can be a corresponding accounting ledger entry for the company. What we do not see is people gifting cash or assets into their FIC, as this is very tax ineffective, so the contribution will need to be recognised in another way.
Typically we see contributions being made in one of three ways. Firstly, the contribution can be made in exchange for shares being allotted by the company, and this can include a share premium amount on top of the face value for such shares. Any value contributed in this way belongs to the FIC absolutely.
Secondly we have a loan structure, where the FIC records a liability owing to the contributing party equal to the value transferred. Tax advice needs to be taken about the terms of the loan, and whether this is interest bearing or not. The receivable of the loan remains part of the estate of the contributing party so would fall within any inheritance tax calculation unless it is transferred out during the lifetime of the holder. Repaying a loan can be a tax effective route of extracting money from the FIC.
Finally, you can have a quasi-equity option such as redeemable preference shares. These are shares of the company, but unlike ordinary shares can, if there are profits, be redeemed by the company to return money to the shareholder and cancel the shares.
Due to the flexibility of funding options, we can tailor the contributions to the specific requirements of each family, depending on their individual circumstances and tax position.
Turning to the inheritance tax position relevant to these funding options. As mentioned earlier, it is tax inefficient to gift cash to a company, and for IHT purposes it is an immediately chargeable transfer for IHT purposes (so subject to 20%) so it is crucial this is avoided.
Whether the funding is by loan or share subscription, the value of the shares or benefit of the loan will form part of the founder’s estate for IHT purposes until such time that that is gifted, for example, to the next generation.
This gift would be a potentially exempt transfer (and therefore under current rules would pass free of IHT if the founder survived seven years). The ultimate shareholders could also subscribe for the share directly, but with the founder paying the subscription price. That payment for the shares is again a potentially exempt transfer.
Importantly, the founder must not derive any benefit from the assets given away for the gift to be effective for IHT purposes.
Even if the founder retains a loan benefit, the structure permits capital growth in the value of the FIC to be outside of the founder’s estate for IHT purposes and to be held for future generations, whilst the founder retains control, in ways that we will come on to later in the series. For some this is an appealing way of transferring wealth to the next generation.
In summary, every FIC is unique, and there is a great degree of flexibility in how they are set up. The key is tailoring the structure to each family’s needs, and their immediate and long-term goals. Look out for future episodes in our Family Investment Company series, the FIC Files.
