Inheritance Tax implications of passing property wealth to children and grandchildren using Limited Companies

Family investment company

A FIC is a private company owned by family members, which can be used as a long-term investment vehicle for passing assets on to your children and potentially mitigating future Inheritance Tax. This is achieved by setting up a limited company with a tailored share structure that assigns different shareholder classes and rights, so that you can protect your assets for the next generation.

At the same time you can continue to have full control during your lifetime, full access to dividend income and also implement a shareholder agreement to protect your property wealth for your children and your future bloodline.

Growth shares and freezer shares

Essentially, when setting up a FIC, a form of planning using “freezer” shares and “growth” shares is used. The intention is to freeze the value of the shares belonging to parents so that future growth in value accrues to their intended beneficiary - typically the next generation who are given the “growth” shares.

This is achieved by altering the company’s Articles of Association to divide the company’s shares into different classes, for example A and B shares, commonly referred to as Alphabet shares. The A shares carry an entitlement to voting and dividends and/or capital on winding up equivalent to the current value of the company and are retained by the parents. The important thing to note here is that when incorporating the company, your current value is equivalent to the nominal value of your A shares. i.e. £1 per share as there are no other assets in the company. So effectively their value is “frozen” at this £1 nominal value.

For example, Mr & Mrs Brown decide to buy property through a limited company. The purchase is of a £300,000 property using a deposit of £100,000 and a mortgage of £200,000. On day one therefore the value of the company shares is nil:

Fixed Asset: £300,000

Directors Loan: £300,000

Outstanding Mortgage: £300,000

Net Asset value: £300,000

Simultaneously, all future growth in the value of the company is assigned to the B shares which will be given to your children or perhaps to a trust that benefits succeeding generations. At this point there should be no IHT implications inherent in this planning. The new B class of shares will have only a nominal value as initially they have no voting rights, no dividend rights and no capital value above their face value.

There has been no significant transfer of value because the value of the existing shares is not substantially reduced. On your death you will be taxed only on the value of the company at the date the two share classes were created, which as we see form the above example is nil, so will revert to the face value of the shares when issued. Normally £1 per share.

The effect of the above is to freeze the value of parents shares and assign all future growth to their children. Over time if property values increase or profits are retained in the company, the value of the company will be increasing. The parentsparents’ shares however will still be worth theretheir value on incorporation i.e., £1 per share and on death can be left to the children. As the children will then inherit the voting rights that come with these shares they have gained effective control of the company and would have avoided IHT.

The same approach can also be used where you have already acquired properties. In this case a valuation would need to be carried out first to ascertain the current value of your shares. This would then be the “hurdle” above which any future value could be assigned to shares issued to you children.

Case study image Case study image Case study image

Case study

As an example, take the case of Mr & Mrs Brown who are aged 42 and 41, have two children aged 7 and 9 and who are both higher rate taxpayers. They have decided to invest in rental properties with a cash investment of £200,000. They decide to buy 2 investment properties worth £300,000 each using a BTL mortgage of £200,000 on each property. They own their main home which is currently valued at £600,000 on which there outstanding mortgage is £250,000.

Mr & Mrs Brown wish to retain the investment properties and maybe acquire more over time. They realise that if they live into their mid-eighties the likelihood is that their main home may be worth £1.5m and that the rental properties could also have more than doubled in value over the next 40 years, to say £1.5m. They expect to have paid off their mortgage on there main house by that time so could be facing a substantial IHT charge on their property assets.

Mr & Mrs Brown, aged 42 and 41

Two children, aged 7 and 9

£200,000 cash investment

By purchasing the properties through a limited company and setting this up as a Family Investment Company, they could achieve the following:

  • By retaining voting rights solely on their shares they have full control over all decision making in the company. This means only they can decide on buying, selling and the payout of dividends or other income from the company and all other decisions. They therefore have full control right up to the date of death of the second spouse, assuming they have mirror wills in pace leaving their individual shares to the surviving spouse.
  • All future growth in value sits with the children’s shares so they can avoid an IHT charge when leaving there voting shares to their children on death.
  • When their children reach the age of 18 they can consider altering the rights on their children’s shares to allow them to receive dividends. This ties in with a time in life when they expect their children will be going off to university and they can therefore pay them a dividend through the company up the value of the personal tax allowance (currently £12,570) to help with university and maintenance fees in a tax efficient way.
  • As higher rate taxpayers they can limit the tax paid to 19% on the first £50,000 of profit.
The company set up on incorporation would look like this:
company set up on incorporation details
Mr Brown

480 Ordinary A shares, voting and dividend rights only

company set up on incorporation details
Mr Brown

480 Ordinary A shares, voting and dividend rights only

company set up on incorporation details
Child 1

20 Ordinary C shares, capital rights only

company set up on incorporation details
Child 2

20 Ordinary C shares, capital rights only

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