Introduction
Trust have been used for 1000s of years to pass over control of an estate to a trusted guardian, trustee, to manage the estate for multiple reasons including inheritance. Trusts were used during the Crusades to allow close family members to manage the family estate while the Lord, Duke or King was away. The estate could be returned once they came back from the Crusade or the heir would take over once they where old enough to manage the estate.
Financial institutions like banks, pension funds and asset management firms are setup like trusts with the bankers or fund managers acting as trustees of your funds, assets and investments. Different trusts have different taxation rules that have developed over the years with 2015 being the most notable.
As of 2015 family type discretionary trusts are now taxable at 39.35% on dividend income, and 45% on other forms of income, removing their historic tax-free status. This has meant discretionary trusts in the UK are no longer an efficient way to build family wealth. They can still be used for non-income producing assets like the family private residence or zero-coupon bonds &/or shares. Therefore, a better solution was created to pass on income producing assets like trading businesses.
The 2024 Autumn Budget has also put a £1m cap on passing on agricultural and business property free of inheritance tax.
How does a Trust Work?
A trust has three main parts:
The Settlor - the one creating the trust and transferring assets into the trust
The Trustee - holding the assets on trust for the beneficiaries
The Beneficiaries - that will eventually receive the assets in the future
No one can be all three at the beginning, otherwise that defeats the purpose of transferring the assets to another on trust.
If the trustee’s responsibilities are to only hold the assets until the beneficiaries get to a certain age, this is called a Bare Trust. If the trustee has discretion on when to give the assets or its income to the beneficiaries, then this is called a discretionary trust.
Guidance is given to the trustees on how to manage the assets on behalf of the beneficiaries via a Letter of Wishes from the Settlor, this is how some form of control is retained over the assets but it is indirect and still at the discretion of the trustees to act in all the beneficiaries interest, not just one or two.
How do I setup a Trust?
A Trust is formed by a trust specialist, usually a chancery barrister, who drafts a trust deed laying out the assets to be placed on trust with the trustees, the trustee’s responsibilities (known as the Trust Provisions), and the beneficiaries.
Once the trust deed with trust provisions are agreed, the settlor and trustees sign the document and the assets are transferred to trustees from the settlor. Usually this is also witnessed or notarised to record the agreement to create the trust. The assets have to be transferred without any reservations or restrictions to be classified as settled property.
Once the trustees have full control over the assets the trust can be registered with the Trust Registration Service (TRS) if required. Annual accounts are maintained by the trustees and made available to the beneficiaries &/or TRS. The settlor can choose if the beneficiaries are informed about the trust in many ways, before, during or after its creation or the trust details can be left as a side note of a will as a reference point to inform the beneficiaries of the existence of the trust.
To open a bank account for the trust if required, a Special Deed of Trust and a trust extract can be made available to the bank. In the UK, trust bank accounts have become harder to open over the years due to all the new regulations and compliance requirements, with some requiring £25,000 - £100,000 minimum deposit to cover these increased costs.
How does a Family Investment Company Work?
A Family Investment Company (FIC) has:
The Founders - that provide the initial capital to form the company and become its original shareholders
The Directors - that manage the assets in the company for the benefit of the shareholders
The Shareholders - which are the beneficiaries of the company’s future income and capital
The same individual can be the Founder, Director and a Shareholder unlike a trust.
A Family Investment Company can be formed as Non-Trading Holding Company to start with, to reduce annual administration costs. Then as the FIC grows it can evolve into a Trading Investment Company, which is better know as a Family Office, with full time employees managing multiple services for the family not just wealth management, legal advice and tax filings.
How do I setup a Family Investment Company?
A Family Investment Company is formed by company formation specialist, usually a commercial barrister, who drafts the Articles of Association and Memorandum of Association with the unique alphabet shares. These shares split up the voting, capital and dividend rights to allow access to all the wealth management, estate, succession, inheritance tax planning techniques and tax reliefs.
Once the Articles of Association and Memorandum of Association are agreed the founders, directors and shareholders sign the Companies House application form, which can all be done electronically by the barrister. Companies House registers the company with the articles and memorandum of association published on the public website.
Once the Family Investment Company is registered on Companies House then a bank account can be opened with most High Street banks as a standard business account with no minimum deposit required.
How to Structure a Trust?
A trust is best structured with one asset class or a set of similar assets to simplify the management by the trustees. It is also best to have similar types of beneficiaries like minors, vulnerable people, employees and family to access the full tax relief only available to each different class of beneficiary. The trustees can be Independent professional trustees, private trustee/fiduciary companies controlled by the family which will have an annual cost, they can also be friends and family or a mix. Ultimately it has to be someone you trust to manage your assets into the future for potentially decades to come. The trust also has maximum length of 125 years which has to be considered.
Also, any annual administration costs have to be factored in and if a bank account is required or who will pay these costs to maintain the trust.
What are the Annual Costs of a Trust?
A trust can have minimal annual costs when it holds non-income producing assets like a property the family live in and the trustees don’t charge any fees. However, there will be the 6% 10-year charge which will require some accounting and filing fees along with the 6% tax. Any income producing assets could have tax filing implications which although small could add up over the years.
A trust has a £500 annual tax-free allowance to receive income to cover these costs and only pay 8.75% dividend tax to cover these expenses over the £500 tax free allowance, however it may be hard to open a bank account for such a low turnover, so the trustees might have to open a personal bank account in their name to manage these small annual fees.
This is why we build in a fiduciary, to act as private corporate trustee, into the Family Investment Company. The fiduciary can open a regular business bank account to manage these smaller sums for multiple different trusts for the family.
How to Structure a Family Investment Company?
A Family Investment Company is created with alphabet shares to separate the voting, capital and dividend rights into different classes of shares, to allow flexibility to strategically place these shares in different holding structures. A Company does not have a limit of how long it can exist for, hence we call it a Perpetual Investment Entity (PIE), whereas a UK trust has a 125 year limit.
The voting shares are retained by the founders, so they remain in control of the FIC and vote to add or remove directors. They also start out as the main directors of the FIC and elect more directors as they slowly hand over the day-to-day operations.
The capital shares are split into fixed capital shares, which are redeemable preference shares, also known as ‘Freezer Shares’. The future growth of the FIC is then placed into non-voting common shares, also know as ‘Growth Shares’.
The growth shares are placed into trust for the grandchildren and future generations, the majority of the freezer shares are gifted to the next generation or employees of the FIC via an employee benefit trust. Given the majority of the employees are the family in a Family Investment Company, this is an alternative to a family discretionary trust with the 6% 10-year charge and potential 20% transfer charge.
Some of the freezer shares can be retained by the founders to fund their retirement, as they can pass on up to the £1m business property relief free from inheritance tax.
The dividend shares are then issued to the founder who can sell or gift to other family members, so they can all receive a dividend as and when required plus use up family members tax free personal allowance of £12,570 + £500 dividend allowance each year.
The FIC is the used to hold shares in the family trading businesses. When these shares are added to the FIC, they are exchanged for equal value freezer shares which fixes the value the founder receives and passing on the future value to the growth shares.
The trading companies added would be subsidiaries of the FIC and therefore the FIC receives dividends tax free from these companies and can then retain them to invest into other family companies’ tax free. This would grow the family wealth quicker than receiving the dividends personally and paying dividend tax, to then invest. The dividends can be paid out to the same family members as before via the dividend shares or redirected to other family members.
When Should I Use a Trust?
A trust is a good way of holding non-income producing assets like the family home or holiday home, along with shares that don’t receive dividends like the freezer & growth Shares of the FIC.
Bare trusts can be used by grandparents to build up funds for grandchildren once over 18 for university expenses, first car and deposit on a home. Due to settlement rules these funds can not really be used before they are 18 for private school fees or their childhood. There are other ways to provide funds for this.
Vulnerable people trusts can be used to provide for living expenses with income from a FIC via a dividend share used to top the Trust up each year rather than have a large lump sum being required. The funds can instead remain inside the FIC to create the investment return rather than in a less tax efficient trust structure plus simply the administrative and accounting costs of the trust.
When Should I Use a Family Investment Company?
A Family Investment Company is a holding company that is created in a way to allow the maximum options to move funds from companies-to-companies tax free and to family members today via the dividend shares or in the future via trusts.
Once your family has a higher income tax bracket issue, a potential capital gains and inheritance tax issue, the Family Investment Company will become a useful tool to mitigate these taxes without limiting your future options by losing control. The FIC is the hub and spokes of a family’s wealth management operation as it allows you use multiple trading companies to separate assets from trading businesses for asset protection, increase investment of funds by reducing personal income, dividend and capital gains tax before being able to invest back into other companies and opportunities.
Trust can be used strategically in a way that minimises taxes overall without the annual cost of maintaining multiple trusts becoming prohibitive via the families own private fiduciary to act as corporate trustee to multiple trust for the same annual administration cost.
Conclusion
The combination of a Family Investment Company and multiple trusts is the modern hybrid model used to gain access to many more efficient wealth creation, estate & inheritance tax planning techniques.
With the 2024 Autumn Budget reducing the agricultural and business property relief to £1m per individual and £2m for a couple, along with pensions now being included in the inheritance tax calculations most family-owned farms and businesses will have an inheritance tax issue today or with the next few years with property and land prices continuing to rise.
Contact us to discuss how to create your Family Investment Company
