The impact of the proposed increase to Corporation Tax, announced in the March 2021 budget, has mainly been considered from the point of view of larger trading companies.
However, Family Investment Companies (“FICs”) might also be affected, and there are planning opportunities and investment strategies that could be pursued by families to ensure that profits continue to be taxed at the 19% rate. Please note that Claritas cannot and do not offer investment advice, and this article has been written solely to draw attention to the tax implications of FICs under the proposed Corporation Tax rule changes.
For the purposes of this article, a FIC is considered to be a private limited company owned by one or more family members as a vehicle for investing the family wealth with a view to capital appreciation, protection and succession planning.
Corporation tax increase – recap
It has been over six months since the Chancellor announced plans for an increase to Corporation Tax, and so as a reminder, the key points are set out below.
- The new main rate of 25% will be introduced from 1 April 2023 and will apply to profits over £250,000.
- The 19% rate will continue to be available to companies with profits of £50,000 or less, and those with profits between £50,000 and £250,000 will pay at the new main rate but with a reduction for marginal relief.
Application to FICs
Owners of FICs whose profits do not exceed £50,000 therefore might think their FICs will be unaffected, and those whose profits are between £50,000 and £250,000 might assume that marginal relief will be available to them to reduce the effective rate of Corporation Tax. However, a key point to be drawn out of the proposal in relation to FICs is that neither the small profits rate nor marginal relief will be available to companies which are classed as Close Investment Holding Companies (“CIHCs”), which will pay tax at the new 25% main rate regardless of their level of profits.
Many FICs will be classed as CIHCs for these purposes. Broadly speaking, a company will be a CIHC unless throughout the accounting period in question, it exists wholly or mainly for one or more of the following purposes:
- The purpose of carrying on a trade or trades on a commercial basis;
- The purposes of making investments in land or estates or interests in land in cases where the land is, or is intended to be, let to persons unconnected with the company.
FICs, by definition, do not carry on trades, as they are investment companies. A FIC which, for example, holds a listed stocks and shares portfolio would be a CIHC and will be ineligible for the 19% rate following the April 2023 changes.
Whilst the carve-out for trading companies is fairly obvious, the extension of this to investment companies whose activities wholly or mainly comprise investing in or holding land and property is important for many FIC owners. For example, those who have used their FICs to acquire and build rental property portfolios (whether commercial or residential), and are renting these properties to third-parties, may fall outside of the CIHC definition and so their profits will continue to be subject to the 19% rate and be eligible for marginal relief between £50,000 and £250,000.
When will a FIC be at risk of being a CIHC?
The phrase “wholly or mainly” is crucial in this regard. Generally, for tax purposes, whenever “wholly or mainly” appears in the legislation, it is taken to mean “more than 50%”. However, HMRC’s guidance also states that a common sense approach should be taken when an company’s status as a CIHC is not clear-cut. A review of all of the facts will be undertaken to consider the relative levels and sources of income, the activities undertaken, what the board minutes reveal about a company’s business and the nature of the company’s assets and to what uses they have been put.
Care should therefore be taken by any FIC owners who have invested primarily in rental to ensure that they do not taint their FIC’s eligibility for the small profits rate by diversifying the investment portfolio (for example, by investing in a stocks and shares portfolios). If the value of investments or the quantum of income which do not relate to property account for more than half of the overall value of the FIC’s assets or half of its total income, or more time is spent managing non-property investments than property investments, there is a risk that the FIC could be classed as a CIHC and would then be subject to corporation tax at 25% from April 2023.
If you or your family own a FIC and would like to discuss the implications for you in more detail, please get in touch with your usual Claritas contact.
