Using a Family Investment Group: practical planning with the new dividend tax rules

//Using a Family Investment Group: practical planning with the new dividend tax rules

Using a Family Investment Group: practical planning with the new dividend tax rules


You may well be familiar with the concept of a Family Investment Company (FIC).

These were viewed as the new alternative to trusts when Gordon Brown,decided to simplify the trust tax regime with effect from March 2006.

From this date, the vast majority of all new trusts would become subject to the Relevant Property regime for Inheritance Tax (IHT) purposes. In other words, tax on entry, tax every ten years, and tax on exit regardless of the type of trust unless one could make use of particular exemptions.

The FIC – What was all the fuss about?

Broadly, the idea was as follows…

A new family Company was formed with the Parents as Directors. As such, they would exercise control of the assets and make day-to-day investment decisions. This would largely be on all fours with the Trustees of a Trust. The Children would then be given shares in the Company – with a high degree of flexibility over the inherent rights to capital and / or income. it may well be that these shares do not have voting rights.

Any value which passed in to the shares of the Children would result in a Potentially Exempt Transfer (PET) and, as such, would not suffer an immediate charge to IHT.

FICs are particularly attractive where the founders are transferring cash. Otherwise, the tax anlaysis can be more complex. For instance, there can be CGT problems (in the absence of any available relief) and, in the case of property, Stamp Duty Land Tax (SDLT) will also be very much in point.

Where this cash is invested in equities, then the dividends on those equities could be received by the FIC free of tax. This enables gross reinvestment of such income within the FIC.

Even where the income is not dividend income, then the 20% rate of corporation tax (which will fall further to 18% over coming years) means that there will be a greater proportion of any investment return to plough back in to the investment business. Of course, one should not forget that where are shareholder takes any funds in to their own hands there will be personal tax consequences.

For the avoidance of doubt, the other features of the relevant property regime  – namely the 10 year charge and the exit charge – will  not apply to Companies.

Dividend tax rules

So we come on to the new dividend tax rules announced at the Summer Budget 2015. These new rules will take effect from 6 April 2016.

The consequences of these changes are as follows:

  • The 10% notional tax credit will be scrapped;
  • The introduction of a ‘Tax-free dividend allowance’ of £5k
  • Thereafter:
    • 7.5% if falls in the basic rate band
    • 32.5% if falls within the higher rate band; and
    • 38.1% if falls within the higher rate band

One of the less commented upon challenges of this legislation is that this represents a significant tax hike for non-residents who are in receipt of UK dividend income?

Take the example of Mr Blue who is the Managing Director of Blue Group. Blue Group is a UK fashion retailer, with a number of different brands, and operates thousands of shops in the UK. Mrs Blue is the majority shareholder. She doesn’t work in the business, and is resident in Monaco. She takes multi-million pound dividends each year.

As the 10% notional tax credit is deemed to constitute basic rate tax deducted source, then this fully extinguishes her full liability to UK income tax as a non-UK resident individual. Up until now, she has paid nothing as the notional tax credit has discharged her full liability to tax.

What about from 6 April 2016? It would seem that Mrs Blue will be subject to income tax on the full amounts received as a dividend at the rates set out above.

So why has such a change been introduced? Although there have been discussions for many years regarding the unification of income tax and National Insurance Contributions (NICs), these specific changes came truly out of left field. It was surprising for at least the following reasons:

  • The proposals were not in the original Budget this year. There were some Summer Budget announcements where it was obvious to see they were Conservative manifesto promises and measures the Lib Dems would not have been prepared to back whilst in coalition Government (for example, the changes to the nil rate band for families with large properties – but with limited other assets). However, this seems to be one policy for which Lib Dem support would not be lacking;
  • Secondly, it comes in a context of various consultations to IR35 etc – one assumes that this was the real mischief being targeted.

Dividend tax changes: a case study

Let’s say Mr X has Company (XTC Trading) worth £5m. He is the sole shareholder in the Company and sole Director.  It makes profits of £1m per annum.

Up until now, as is typical of SMEs, he has taken a small salary of £12,500 per annum and paid himself dividends of between £300k – £400k per annum. This year he has paid himself a dividend of £350,000. He has other income – including his salary, a consultancy fee and property income – which already takes him in to the 45% tax bracket.

For the current year, his tax bill in respect of his dividends is:

Taxable dividend        350,000
Effective rate


Tax due        107,100


Going forward, his tax bill in respect of his dividends will be:

Total dividend        350,000
Less: allowance –          5,000
Taxable dividend        345,000
Effective rate


Tax due     131,445.0
Difference       24,345.0


This represents a significant increase in Mr X’s annual tax liability. I am sure he is relieved that the Conservatives introduced the income tax ‘lock’ guaranteeing no tax rises!

What might Mr X do now?

Consider maximising dividends prior to the 6 April 2016. This might include clearing out the Company’s distributable reserves.

One could of course loan the money back to the Company to provide working capital if cash was required in the business.

What might Mr X do going forward?

One might also consider putting in place a Family Investment Group (FIG). This would involve Mr X establishing a new holding company. He might then consider selling his shares in XTC Limited to the new holding company.

On the Sale of the shares, the consideration is left outstanding. This creates a loan account in Mr X’s  favour for £5m. Mr X may draw down on this loan free of further tax in the future.

The sale, assuming the Company qualifies for Entrepreneurs’ Relief, would crystallise a tax liability of £500k (assuming no base cost of the shares for CGT purposes). If that sale took place in December 2015, then the CGT would be due then this would be due by 31 Jan 2017. If the Company carried on its present level of profitability it could have potentially have paid down (to Mr X) £1-1.2m of this loan account. Therefore client would be ‘in the money’ and able to pay the CGT.

As discussed earlier, XTC Limited can pay up dividends to FIG without corporation tax. Alternatively, FIG could then invest directly or indirectlyin to another commercial project.

Is there a risk of Transaction in Securities anti-avoidance legislation biting? These provisions try to prevent one converting profits which would be subject to income tax in to a more favourable capital treatment? This would need to be reviewed, and addressed, on a case-by case basis.

From an IHT perspective, is there a risk that the group is no longer a trading group? This could be the case where the new project is a non-trading project and its value becomes proportionally significant in respect of the overall group. This could be addressed internally. Alternatively, it could be used by sheltering the value of the group (or parts of the group) within a structure.