An increasing number of individuals are setting up Family Investment Companies; these are simply companies within the scope of UK corporation tax which invest family money and whose shares are owned by family members. These companies are used for long-term investment of family wealth, because the relatively low-tax environment allows for the compounding of after-tax investment returns more effectively than if the investments are held personally. If money is paid out from the company as a dividend, then income tax is payable on the dividend, so again, the companies are used as a long-term vehicle, as the benefit is relatively limited if the company pays out all investment returns as they are realised.
The use of such companies has arisen primarily because of the difference in corporation tax rates (currently 19%) paid by companies on income and gains, and income tax and capital gains tax rates (up to 45% and 28% respectively) paid by individuals.
The Conservatives have said that they will not implement the proposed reduction of corporation tax from 19% to 17%, whereas the Labour manifesto proposes to increase the rate to 26%. However, Labour also propose to increase the top income tax rate to 50% and to increase the top capital gains tax rate to 50%.
What this means is that, if the Labour proposals are implemented, the benefits of a family investment company would be only slightly eroded, in terms of reducing the ongoing tax on the investment return as compared with the tax paid by an individual making the same investment.
The following table shows the effect for investment income.
|Investment return of £100 taxed as income||Current rates||Proposed rates|
|Individual can reinvest||£55||£50|
|Company can reinvest||£81||£74|
|Company can reinvest more than individual by||£26||£24|
Currently, the income tax rates on dividends are lower than the rates of tax on other income, in effect to take account of the fact that dividends are paid out of company profits which have already been subject to corporation tax. Labour are proposing to tax dividends at the same rate as other income, up to a top rate of 50%. Therefore, using savings to equity-fund a Family Investment Company will increase the total tax liability if the company pays out the investment return as a dividend at the end of the year, so that you are worse off than simply investing as an individual. However, such a company still has value as a long-term deferral strategy.
The proposal to align capital gains tax rates with income tax compared would create a greater incentive to use family investment companies when investing for gains.
|Investment return of £100 taxed as a capital gain||Current rates||Proposed rates|
|Individual can reinvest||£80||£50|
|Company can reinvest||£81||£74|
|Company can reinvest more than individual by||£1||£24|
Additionally, a combination of the proposed abolition of entrepreneurs’ relief (which reduces an individual’s effective rate to 10%), and the ability of companies to utilise the substantial shareholder exemption to allow qualifying sales of stakes in trading companies to be free of corporation tax, would make companies more attractive.We have advised on a variety of different circumstances in which Family Investment Companies can be used, and there are other potential advantages in addition to the tax rate on returns. If you would like to discuss setting up such a company, contact Trident Tax Ltd.