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Keep it in the family!

Mark McLaughlin looks at family investment companies and a possible challenge by HMRC on the effectiveness of such structures for inheritance tax purposes. 

A family investment company (FIC) is a possible means of passing family wealth down to adult children and remoter generations. Furthermore, an FIC can be a tax-efficient ‘wrapper’ for individuals to manage their wealth.  

An FIC is simply a company; its shareholders are family members. For example, parents could apply their wealth for the benefit of (say) an adult son and daughter through an FIC. The FIC might be funded by cash initially, and subsequently acquire (say) commercial properties in the UK.  

What’s it worth? 

A gift of shares from parents to adult children is a potentially exempt transfer, so no immediate inheritance tax (IHT) liability arises; a gift generally becomes exempt if the parents survive at least seven years.  

Furthermore, any subsequent growth in value following an outright gift of the shares will normally fall outside the parents’ estates (nb care is needed that the ‘gifts with reservation’ anti-avoidance provisions do not apply to treat the shares as remaining in the parents’ estates). 

If the company’s shares are spread between each parent and adult child (e.g. 25% each), the separate share values are likely to be subject to discounts (e.g. to reflect non-controlling interests in the company), which may further reduce IHTexposure in the parents’ estates.  

HMRC attack? 

It was reported in Taxation magazine (18 March 2020) that HMRC has set up a ‘secret unit’ looking at how FICs are being used in IHT planning.  

Prior to that, a Shares and Assets Valuation (SAV) Fiscal Forum meeting in October 2018 addressed HMRC’s concerns about FICs:  

‘[An HMRC representative] explained that SAV has begun to see companies with classes of shares that include a class with all voting rights but no rights to income or capital, plus one or more classes which have no voting rights but all rights to income and capital. It has been proposed by some agents that the voting classes have nil value. Whilst each case should be judged on its own merits, SAV may challenge a case where nil value is proposed for shares in the voting class. [The HMRC representative] read aloud an excerpt from the Holt v Holt decision, in which the Court suggested that the fair value of control was 20-25% of the company’s value.’  

Share rights 

The case mentioned (Holt v Holt [1990] 3 NZLR) is a New Zealand matrimonial law case. A divorcing couple’s home was owned by a company. Its share capital comprised 1,000 shares of $1 each. There were two classes of shares in the company. The husband held one ‘A’ share; the other 999 ‘B’ shares were held by the trustees of a family trust. 

The rights attaching to the ‘A’ and ‘B’ shares were identical except that the ‘A’ share carried 10,000 votes, while the 999 ‘B’ shares carried one vote each. The company’s net asset value was $800,000. The husband argued that the value of his ‘A’ share was $10,000. However, the New Zealand courts held that the value of his ‘A’ share for matrimonial property purposes was $150,000.  

Practical point 

If the decision in Holt v Holt is followed by the UK law courts, FICs may become less effective to families in reducing IHT on their estates. It is also possible that a targeted anti-avoidance rule may be introduced.