There was nothing new in the Autumn Statement that had an impact on Family Investment Companies (“FICs”). However, now the corporation tax rate increase in April is fixed, it is worth considering the effects this has on the investment return in a FIC.
Dividends
There are two significant points here. Firstly, the rise in the corporation tax rate to 25%. There is a marginal rate of 19% retained for small companies, but this won’t apply to Family Investment Companies because the close investment holding company rules will be reintroduced so that the 25% rate applies.
Secondly, dividend income tax rates were increased when the 1.25% social care levy was introduced as additional National Insurance Contributions, but when the NIC increase was reversed the dividend tax rate remained unchanged. For higher rate taxpayers, the tax rate on dividends is 39.35%.
Typically, a FIC is funded with a loan, so that any cash coming out of the company does so as a tax-free loan repayment. Most dividends received by FICs are free of corporation tax, meaning that the proceeds can be paid out as a loan repayment, also free of tax. This compares very favourably to the dividend rate of 39.35% that would have been suffered by an individual with taxable income over £125,140 if they had invested personally.
Capital gains
The position on capital gains on a typical financial investment portfolio is less favourable, as the gains will be taxed at 25% in the FIC rather than 20% for personal investments.
Many individuals use FICs as holding companies, a variation on the standard portfolio-holding FIC, and hold significant stakes in trading companies, for example family businesses or equity funding of new companies, (often where the shareholding exceeds the limits for the Enterprise Investment Scheme). If a capital gain is realised on shares in a trading company that represent at least a 10% shareholding and have been held for at least 12 months, gains are free of corporation tax because of the substantial shareholding exemption (“SSE”). Where both gains and dividends in the FIC are tax-free, this enables profits to be reinvested in the next venture.
If SSE is not available, the corporation tax on the gain is 25%, as compared with 20% if the individual had realised the gain. For some FICs, holding shares in non-trading companies, or shareholdings of less than 10%, it might be worth considering transferring the shares out as a “repayment in kind” of the shareholder’s loan before significant gains have arisen, or where any gain can be covered by realised capital losses in the company. This could be particularly effective if the individual who receives the loan repayment has capital losses of their own to offset against any future gains from the shares received. However, there would be a stamp duty cost of making such repayments in kind, at 0.5% on the value of the shares.
Interest income
Interest received by an individual is taxable at up to 45%, interest income in a Family Investment Company will be taxable at 25%, but importantly, the interest in the company is taxable as it accrues rather than when it is received. So given a smaller difference between the tax rates, the tax payment date difference may be more significant. For a loan note where the interest accrues for several years, rather than being paid annually, it’s less attractive to hold this in a Family Investment Company.
However, where interest is paid regularly, rather than accrued, there may be a timing advantage of using a FIC. This is because where a borrower pays annual interest to a UK company, it is not required to pay withholding tax at 20%, as would be the case if the interest was paid to an individual. The tax that the individual suffers is offset against their income tax liability but is paid earlier.
Summary
With corporation tax rates on a Family Investment Company at 25%, the tax payable on dividend income is now much reduced by holding the shares in the company, but the tax payable on capital gains outside SSE is now increased by holding the shares in the company. When setting up a Family Investment Company, more consideration may be needed as to the particular investments that are selected to achieve optimal results.
