Increases in tax burden predicted as UK tax man targets family offices

Families are being advised to get their financial affairs in order and brace for an increase in tax bills following the revelation the UK’s tax authority set up a secret unit to probe family investment companies, specifically their use by the wealthy to avoid inheritance tax.

A freedom of information request by law firm Pinsent Masons revealed HM Revenue and Customs (HMRC) launched a specialist team in April last year. The Family Investment Companies Unit conducts risk reviews of private companies used by family offices and high net worth individuals to manage their wealth. Family Investment Companies (FICs) were popular amongst ultra-high net worth (UHNW) individuals and families because they allowed for greater control over assets and investment strategy than by outsourcing the role to private banks and investment managers. FICs also helped families pass on assets and facilitated succession planning.

Pinsent Masons said HMRC may also be concerned about how FICs could act as a gateway for UHNW individuals to move assets offshore in the long term. For example, FICs could be used to transfer assets to another company incorporated in a lower tax jurisdiction overseas.

“Setting up this new unit is a clear statement of intent—to ensure that HMRC maximises revenues from the UK’s richest families,” Steven Porter, partner at Pinsent Masons, said.

Families and FICs

The number of UK family offices, among the most frequent users of FICs, has more than doubled in number to 1,000 since 2008, and now managed more than $1 trillion (£700 billion) in assets, according to the Family Office Council. The UK was also home to a large proportion of the world’s UHNWs at 1,528 individuals in 2019, Credit Suisse found.

There were 2,300 single family offices in Europe with an average wealth of $1.4 billion, according to The Global Family Office Report 2019 by Campden Wealth with UBS. The average assets under management of a European single family office was $861 million, $60 million more than the global average.

Family advisers and lawyers approached for comment by CampdenFB said they were not surprised by HMRC’s crackdown on whether wealth-holders were operating in line with UK tax laws.

Over the last five years FICs had grown in popularity and became far more widely used, David Webster, partner at law firm Russell-Cooke and member of the firm’s family office team, said. Given the estimated value of assets held by those companies, it was natural HMRC would want to look at it.

“However, a FIC is not a magic bullet which will offer protection from inheritance tax and other tax charges,” Webster said.

“It needs to be used carefully—for example, a newly incorporated FIC will generally need to be funded with cash rather than the transfer of assets. It also—as with a discretionary trust—introduces an additional taxable person into wealth planning considerations. A FIC may pay corporation tax on its own profits at lower rates than personal income tax, but recipients of any payments out of the FIC will still be liable to personal tax when money is extracted.”

Webster said the use of a FIC also brought other considerations into play. Unlike with a discretionary trust, a FIC will be subject to company law, and anyone who holds a share in the FIC would have an asset which will form part of their personal property in the event of bankruptcy, death or divorce. A FIC structure was far more susceptible to disputes than a standard discretionary trust, he said.

“Additionally, a FIC is not a distinct type of entity, it is a company which is being used for a specific purpose. Whilst it is natural for HMRC to want to look into their use, there does not seem to be any legitimate basis for a general crackdown on their use as a proper wealth-planning tool—unless what is envisaged is a far more fundamental revision of the landscape generally. Indeed, taking into account the increasing focus on sweeping reforms to inheritance tax and capital gains tax, HMRC’s move is perhaps less of a surprise. The recent report of the All-Party Parliamentary Group for Inheritance and Intergenerational Fairness suggests a complete overhaul of inheritance tax—not least abolishing business property relief and introducing an annual gift allowance—suggested to be £30,000. Any gifts over and above this would be taxed at 10%.

“Using a FIC instead of a discretionary trust has advantages, but also disadvantages. If set up without proper care it could have very serious negative consequences for a family, both in relation to tax but also broader family relationship concerns. Even a carefully set up FIC won’t be right for everyone.”

What next?

Geraint Jones, head of private client services at BKL, said HMRC was apparently concerned that FICs offered a route to considerably reduce inheritance tax liabilities, largely by bringing an estate and its beneficiaries into the fold of a company structure as shareholders.

“If the review is concerned with flowering share structures as an avoidance device, the best advice is to sit tight at this stage,” Jones said.

“The FIC structure still offers clearer advantages than disadvantages when it comes to protecting wealth, particularly since trusts have fallen out of favour.”

However, Camilla Wallace, partner and head of private client group at Wedlake Bell, said a FIC enabled parents to retain control of the family wealth while ensuring capital can grow in the hands of the next generation.

“Pooling investments enables family members to be engaged and over time the next generation can sit on the board,” Wallace said.

“Furthermore, asset protective clauses can be included in the articles of association to assist with relationship breakdown. In short, they are favoured by entrepreneurial families looking to carry out succession and responsible estate planning, but inheritance tax is not usually the principal driver.”

Natalie Sherborn, partner at Pinsent Masons, said it remained to be seen if the Family Investment Companies Unit's focus on UK FICs will also result in an increased appetite to refer criminal offending, "whether by the FIC or the ultra-high net worth individual, to the prosecution agencies for criminal sanction to send a strong deterrent message.”

Webster said so far, HMRC had been noticeably short on details. It may be the tax authority had concerns that FICs were being used in a non-standard way for the purposes of unacceptably aggressive tax avoidance, either in their own right or as part of wider artificial structuring arrangements.

“If that is the case, then—much like the introduction a few years ago of rules to prevent the artificial treatment of employees as members of LLPs—the introduction of focussed and specific anti-avoidance rules may in fact be a welcome development.”

Stephanie Parker, trust director at tax advisers haysmacintyre, said HMRC may be considering whether the normal valuation models are appropriate in FICs, and whether the levels of discount applied in a family situation should be reviewed. The FIC unit may also be considering the value of a parent’s right to vote, even if they give away all of the income and capital rights, Parker said.

“HMRC will also be looking into the possibility of there being transfers of value between parents and children through changing the rights of shares after they have been issued—these could immediately be chargeable to inheritance tax, so any changes must be approached with due caution.”

Parker said those considering setting up a FIC need to be aware of the risks of any changes in legislation or in HMRC practice and consider how they would deal with it from the start.

“It is essential to get the right classes of shares issued to the right people from the outset, as changes at a later date can be difficult to achieve and give rise to risks of extra tax charges. Before embarking on the Family Investment Company route, detailed professional advice should be sought—else the errors could prove expensive.”

Wallace said Low Corporation Tax rates were attractive, but good advisers will warn against planning on such rates remaining low indefinitely. Coupled with the All-Party Parliamentary Group Report on changes to inheritance tax, family offices should not be surprised if the UK government's scheduled budget on 11 March announced a consultation which might affect FICs or even introduce changes immediately.

“If a FIC is being considered then the planning could be accelerated, particularly if it involves large cash gifts to family members, Wallace said.

“That said, if tax rates do go up, tax on the winding up of the FIC needs to be considered. The objectives behind the FIC together with the relative value of asset protection and responsible estate planning in a pooled family vehicle need to be weighed up against possible punitive tax changes.”

Tahina Akther, head of the family finance team at College Chambers, said the new FIC unit, along with the Ultimate Beneficial Ownership legislation, suggested the focus of HMRC this year.

“I predict both combined will give rise to significant increases in tax bills to the wealthy in the near future.”