The Family Investment Company – A Tax Albatross?

Articles 14.05.2018 Author: Robert Maas

Robert Maas, Tax Consultant at CBW, provides new approaches to the old problems arising from family property investment companies.

This article was first published in the May edition of Property Investor News, a monthly magazine providing news analysis and professional research for the discerning private investor/landlord.

In general, family property investment companies are bad news. The shares do not qualify for either CGT (Capital Gains Tax) entrepreneurs’ relief or inheritance tax business property relief. Although there is an uplift in the CGT base cost on the death of the parents, this applies only to the shares; the underlying properties retain their historic cost (or 1 April 1982 value). Furthermore, the next generation is unlikely to have inherited Dad’s property expertise and even less likely to be able to agree amongst themselves what to do with the portfolio. Sadly, that can be a quick route to siblings falling out with one another. Those who are rushing to incorporate buy-to-let portfolios often seem oblivious to these problems.

But none of these problems existed in the 1950s, when many family investment companies were formed. Many such companies are now left with elderly controlling shareholders dependent on the dividends they draw from the company and often decaying portfolios in need of redeveloping or refurbishment.

What can be done? In many cases little or nothing. The parents can pass shares to their children and hope to survive for the seven year PET (potentially exempt transfer) period, but the need for income often limits the scope for doing so. So often does a reluctance to pass control to the next generation.

In some cases a possible solution is to split the share capital into income and capital shares with the income shares being held by the parents and the capital shares by the children. This is not simple to do though, as it is not easy to value such special classes of shares and getting the value wrong can cause more tax problems. It is also only a partial solution as some value has to remain in the parent’s estate on death as the income rights cannot cease on death, albeit that they can be for a limited period. An alternative is “freezer” shares, where a new class of shares entitled only to the growth in the value of the company’s assets is created and gifted to the children. This leaves the current value frozen in the parent’s hands, so again is a partial solution only, and again suffers from valuation problems and the need to carefully define the share rights to avoid a reservation of benefit.

In the right circumstances an attractive option can be to convert the property into a trading company whose trade is the development and sale of the properties. In the right circumstances, because this is something that has to be done properly and thoroughly as it is bound to attract scrutiny from HMRC and needs to be able to withstand such challenges.

In theory, it is easy to convert an investment company to a trading company. The directors pass a Board Minute that says they no longer regard the properties as investments but are now holding them for sale. There is no tax on the “appropriation” to stock, provided that an election is made to hold over the capital gains that arise on the appropriation. In effect, this turns the capital gains into trading profits when the property is sold. Becoming a trading company is good news for CGT as on a sale more than 12 months later, the shares attract entrepreneurs’ relief, which halves the CGT.

But the facts need to follow the intention. It is not enough to say the properties are now stock. Stock is held for sale. The properties must be sold or refurbished or developed for sale. If that is not done, HMRC are unlikely to accept the change of status. Of course, it does not all have to be done immediately. Property dealers normally wait for the best time to sell their properties and, in the current market, this could be in several years’ time. But there must at least be a credible plan to sell the properties.

Developing for sale is much more attractive than simply selling off the portfolio, because a genuine development company will attract not only CGT entrepreneurs’ relief but also IHT business property relief. This is given for trading but there is an exclusion where the company’s trade is buying and selling land. Developing the land takes the trade outside this exclusion. Because of this benefit, expect a fight with HMRC if Mum or Dad dies before development is well under way.

Again, it is not necessary to develop everything at once. Few developers do that. They normally have a stock of sites awaiting development (or building awaiting redevelopment) and develop one or two at a time. But it is important to show that everything is held for development and to be able to demonstrate that everything is capable of development. If one or two buildings are not development propositions, that is not fatal. What needs to be shown is that the business consists wholly or mainly of developing. If not all the properties are held for development but the wholly or mainly test is met, the shares attract BPR but the part of the value that represents the non-qualifying properties is excluded from relief.

About the Author

Robert Maas

Tax Consultant +44 (0)20 7309 3800