RSM's Chris Etherington warns that HMRC has set up a special unit to evaluate what risk Family Investment Companies present to tax receipts.
It has been revealed that a secret unit has been set up by HMRC to review the tax risks of Family Investment Companies (FICs), in particular the associated inheritance tax (IHT) implications, but should families who have established a FIC be concerned?
For those unfamiliar with the concept of a FIC, it is simply a company, typically set up in the UK, which holds investments that would otherwise be held by family members personally. The FIC is often established by a parent or grandparent according to their wishes, with family shareholders having particular voting rights and differing entitlements to income or capital from the FIC on a winding-up.
FICs have become particularly popular in the last ten years or so and their rise can be matched to a corresponding decline in the use of trusts in the UK. Both types of structure are commonly used to achieve a similar objective: a desire by parents to pass assets down to the next generation whilst retaining some control of those assets during their lifetime. The key difference is in how the two types of vehicle are taxed.
It could be argued that if HMRC perceive there to be a problem with FICs, it is a problem of their own making. The number of tax-paying trusts in the UK has reduced by about a third since 2006 when substantial changes were introduced to the way trusts are taxed, making them more costly to fund as a potential 20 per cent upfront tax charge can arise on assets settled on trust.
The underlying objective of splitting out who controls an asset from who can benefit from it is not a new one though. It has been around for centuries and underpins why trusts were created in the first place. It should therefore come as no surprise to HMRC that the barriers they have introduced for trusts have led to individuals looking at other means of achieving that objective.
So why the need for a ‘secret unit’ to look at FICs and what steps might it take? The news of ‘secret units’ will naturally cause concern for some but it is perfectly reasonable for HMRC to want to look at this type of arrangement more closely. Trusts have been subject to a number of consultations to consider whether the inheritance tax advantages associated with them are appropriate and rumours abound that we may finally see some more changes to the taxation of trusts and IHT in general in the forthcoming Budget. This ‘secret unit’ could simply form part of a much wider review and it would be unusual if FICs did not form a part of it.
The information disclosed by HMRC was understandably limited but we did learn that the team sits in the Wealthy and Mid-sized Compliance Directorate and we have seen some recent experience of the approach taken by teams in that department.
In particular, there seems to have been a shift in the approach in how enquiries into an individual’s tax affairs are undertaken. In the past, a traditional enquiry has focused more on the detail of what has been done, looking at the steps undertaken and whether anything has been overlooked. A perceived shift is that teams in this unit have looked more at the overall purpose behind what a taxpayer has done, rather than flaws in the specific steps they have undertaken. It seems more of a focus on whether it is reasonable behaviour and in the spirit of the law.
For a typical FIC, it is difficult to see how an Inspector could conclude the overall purpose was inappropriate. Clearly the focus of the unit is on inheritance tax and whilst FICs do allow for families to manage their exposure to IHT, the way that is achieved is not significantly different to any normal gift.
If a parent gifts an asset to a child and survives that gift for seven years, it will usually fall outside the IHT rules. The difference between that scenario and a FIC is that a parent will gift the child shares in an FIC, which holds the asset, rather than the asset itself. The FIC allows the parent to control the asset until such time that they think it is appropriate for the asset to be transferred to them directly.
If it is accepted that there is no problem making a simple gift, then the retention of control will be addressed. One might argue that has been acceptable planning since the 12th century when trusts were first established.
There will no doubt be cases and areas where individuals have not considered the tax risks associated with establishing their FICs and it will likely be worthwhile undertaking a review of those before HMRC do so. For many though, the news that HMRC are looking more closely at FICs should not come as a surprise given the rise in their popularity and we await the Budget to see if there are any further developments on IHT in general.