How can you pass assets on to future generations tax efficiently while maintaining some control? Trusts have been the traditional answer, but there are now alternatives worth considering.
Family investment company: friend or foe?
A family investment company is a bespoke limited company that can hold a broad range of assets including property, cash and investment portfolios. It provides a tax efficient way of accumulating income while retaining control of the assets in the company. It can enable you to provide for your children and is a good wealth planning tool.
If you are thinking about setting up a family investment company, you will have to decide who to appoint as directors to manage the company. You can be a company director yourself as well as a shareholder, which would give you more control. Keeping assets within a family investment company can offer attractive tax benefits because income and gains kept within the company are subject to corporation tax, rather than income and capital gains tax as for individuals. The current corporation tax rate is 19% and will reduce to 17% from April 2020, which compares favourably with income tax rates of up to 45% and capital gains tax rates of up to 28%. Importantly, dividend income can be received free from UK taxation.
You will need to plan carefully to minimise tax liabilities when extracting profits from family investment companies, as there are several options to consider. Common methods of extraction include dividends, salary and pension contributions.
Family investment companies can issue different classes of shares with different rights. This can ensure that different shareholders have different entitlements to dividends, capital and voting rights. If you are concerned about keeping your financial affairs private you might be reluctant to register a limited company, which must file information such as accounts which are available publicly on the Companies House website. If this is a problem for you, then you could instead register your family investment company as an unlimited company, although there are other legal differences with this type of company to consider.
Family limited partnerships
Another alternative family investment vehicle is a family limited partnership. This can offer greater flexibility over the entitlements of each partner to income, gains and capital of the partnership. For tax purposes, partnerships are ‘transparent’, which means that the partners are taxable on an individual basis on their share of the partnership profits, investment income and on any capital gains. Income is taxed at personal tax rates of up to 45%, even if the partners do not physically receive anything.
When setting up a family investment partnership, there are many decisions to make. You will need to appoint at least one ‘general partner’ with the authority to bind the partnership. You will also need to appoint at least one ‘limited partner’. Senior members of the family could therefore act as the general partner to retain control.
A partnership agreement should set out each partner’s entitlement to income and gains. It can also include details of when and how funds are distributed.
Trusts remain a popular way to hold property for the benefit of the next generation. Advice will be required to plan a transfer of assets into trust so that the ‘trustees’ take responsibility for those assets for the benefit of a stated class of ‘beneficiaries’. If you or your spouse establish a trust and transfer assets to it then you are the ‘settlor’ and ideally should ensure that once property has been transferred that you cannot benefit from it.
Under a discretionary trust, the beneficiaries only have a ‘discretionary’ entitlement to assets. This means that the trustees have total discretion as to the distribution of trust income and gains to the beneficiaries. This arrangement ensures trust structures remain attractive even where there might be concerns about how the trust property is used. For instance, where there are beneficiaries who do not have capacity for financial decisions (for instance minor or young adult children), or in case of potential future relationship breakdown or bankruptcy.
You will have to consider the tax consequences of creating a trust, along with any anniversary and distribution charges during the life of the trust. For example, the rate of inheritance tax charged on transferring property out of a discretionary trusts or at the 10-year anniversary date could be up to 6%.
Discretionary trusts are subject to special rates of tax on income received. Income distributions to beneficiaries are made net of a 45% tax credit, although beneficiaries can recover some or all of the tax credit where their personal income is taxable at a lower rate.
Trusts are also entitled to half of an individual’s annual exemption, being £6,000 for 2019/20. Any chargeable gains are currently taxed at 20%, with an extra 8% for gains on the disposal of residential properties.
While trust taxation is complex there is scope for reducing long term tax liabilities. As settlor, you can control assets and manage them for future generations without them being considered part of your personal income declarations or estate for inheritance tax purposes.
Family dynamics will usually dictate the best way for you to hold property for the benefit of future generations, but the comparisons given above do illustrate that genuine choice exists.
Lynne Rowland is a personal tax partner at Moore Kingston Smith. Find out more about our private client services at www.mooreks.co.uk/people/lynne-rowland