The benefits of using a company structure in later life planning
A friend’s son boasted that he has a job handling the finances of a multi-billion pound international company. He works on the check-out at McDonalds!
This particular dad joke serves to illustrate that the term “company”, and its relationship to those associated with it – employees, customers, the business – can sometimes mask reality.
The reality is that a company can house any type of enterprise (a business, a trade, a charitable endeavour) that can be of any size and complexity. This means that a company can provide a very useful tool in planning – not only planning for tax efficiency but for succession, wealth protection and a host of other objectives.
Why would you want to use a company?
It may be best to start with the opposite question – why wouldn’t you?
Serious obligations accompany the creation of a company. There are legally required reporting and disclosure requirements including the need to prepare accounts, submit Companies House Confirmation Statements and other returns. The Directors have a fiduciary duty to safeguard the interests of the company and its shareholders. None of these obligations should be taken lightly and some will entail a level of financial cost. Companies House disclosures also require an element of transparency of some business information (although for smaller companies, little financial detail will need to be made public).
Against these considerations needs to be balanced a plethora of advantages.
The tax benefits of using a company stem largely from the differential between tax rates for companies and those for individuals. There are also a number of more nuanced tax benefits, some of which are touched upon in this article. Currently, profits and gains of a company are taxed at a corporation tax (CT) rate of 19%. That rate is now set to rise to 25% from 1 April 2023 but the 19% rate will remain for companies with annual profits of up to £50,000, with marginal relief applying to profits over £50,000 up to £250,000.
These rates compare with rates for individuals of income tax (IT) of up to 45% (there is of course in fact a 60% marginal IT rate on a £25,000 slice of income for some) and capital gains tax (CGT) rates of 28% on certain assets. That is not the end of the story since, to access the profits of a company a shareholder will incur further tax charges. But there will often be opportunities to plan to alleviate the cost.
Shares in a company normally lend themselves better to simple Inheritance Tax (IHT) and succession planning. Gifts of shares are, legally, simple. Furthermore, a range of planning opportunities may be accessed by shareholders in a company that are not available to sole traders. These range from the simplest valuation effects to complex trust arrangements.
Not least, of course, a company provides limitation of liability. It is to be hoped that is never of significance but in terms of providing peace of mind this feature is often valuable.
These are only some examples. There is a wide variety of circumstances where a company will provide commercial, tax and practical benefits. In this article we consider three instances in which the use a company is likely to find favour compared with any alternative.
Where, say, married partners own a residential property portfolio, the transfer of the properties into a company may provide a number of benefits.
In calculating the taxable income of UK residential property owned by individuals, no deduction is now given for the cost of interest on borrowing. Instead, a basic rate tax credit is available. There is no such restriction in a company where full relief will be available to set against rental income. Furthermore, on incorporation, the CGT base cost of the properties will be uplifted so that any sale of the properties at the market value on incorporation will be tax-free.
Of course, a tax-free incorporation is possible only in certain circumstances. There needs to be a business (so that CGT can be relieved) and the married couple in this example would need to be operating in partnership (so that there is no stamp duty land tax charge). However, that is frequently the case even in circumstances where it is not expected.
Personal trading company
Where an individual carries on a business (apart from, broadly, an investment business) the value of that business can qualify for IHT Business Relief (BR). Where available, the relief can reduce the value of the asset for IHT to nil. Virtually all trades will qualify for the relief (with the exception of a property dealing or share dealing trade).
There are various conditions for the relief. The business needs to have been owned for two years at the date of transfer. If the business is gifted and then is sold or ceases in the ownership of the transferee, the protection of BR on the gift may be lost.
A company can alleviate the effect of some of the conditions and restrictions on BR. Where the business is carried on within a company, the asset for IHT will be the shares and the ownership test will be by reference to those shares. In other words, a company can be set up and later acquire a qualifying business but the two year period will already have started. If the business is terminated and a new one acquired, the ownership period will not be disturbed. If the shares are gifted and then the company ceases to trade, the gift still qualifies for BR.
Furthermore, the company in these circumstances may be used to shelter other non-trading assets. If the company carries on a hybrid business (combining trading and investment), then a certain value of otherwise taxable investment assets may be brought under the protection of the BR corporate umbrella.
Family investment company (FIC)
Where a business or trade is carried on within a FIC, there may be a string of advantages for IHT and succession planning.
For example, if five family members decide to operate a business through a jointly owned company they may be surprised to find that the IHT value of the asset they own is immediately lower than a corresponding proportion of a partnership. This is a consequence of share valuation principles.
Special shares can be created in the company that have little or no taxable value at the start but which will accrue value over time (“growth shares”). These can be gifted tax-free into trust or to beneficiaries. This arrangement can also be used in any other company, such as a personal trading company. Different classes of shares can be issued to allow the most tax-efficient distribution of income.
The circumstances where a privately-owned company may provide benefits are legion. More elaborate arrangements can be used alongside a company to achieve greater tax efficiency and secure other advantages. However, even in simple situations involving relatively small business interests, corporate business ownership will often be an attractive choice.
To find out more about using a company structure in later life planning, click here.
Written by Tom Moore
Stellar Asset Management Limited does not offer investment or tax advice or make recommendations regarding investments. Prospective investors should ensure that they read the brochure and fully understand the risk factors before making any investment decision. The value of investments and the income from them may fall as well as rise and is not guaranteed. No assurance or guarantee is given that any targeted returns will be achieved. Forecasts of potential future results are not a reliable indicator of actual future results.
Stellar Asset Management Limited of Kendal House, 1 Conduit Street, London W1S 2XA is authorised and regulated by the Financial Conduct Authority.