Discretionary Trusts vs Family Investment Companies
Every succession planning transaction must be analysed through two lenses simultaneously: Inheritance Tax (IHT) and Capital Gains Tax (CGT). The instinct of most advisers, and clients, is to focus on IHT, particularly given the scale of the changes that took effect from 6 April 2026. But CGT is an equally real cost, arises at the point of transfer, and can be unrelieved in circumstances where the IHT position appears comfortable. Treating the two taxes as separate exercises, rather than as a single integrated analysis, is one of the most common and costly mistakes in this area.
The Post-April 2026 BPR Landscape
The Autumn Budget 2024 raised the threshold for 100% Business Property Relief (BPR) to the first £2.5m of qualifying business and agricultural property per individual — following a subsequent government announcement in December 2025 revising the original £1m cap upwards. Above £2.5m, relief falls to 50%, giving an effective IHT rate of 20% on the excess. Where both spouses hold separate qualifying interests, a couple can shelter up to £5m at full relief. For transfers into trust, the relevant property regime still applies and both the entry charge and the periodic ten-year charge must be modelled carefully alongside any CGT exposure.
IHT and CGT: A Structural Comparison
The Hidden Cost of the Ten-Year Charge
One of the most underappreciated risks in the discretionary trust structure is the ten-year anniversary charge. At up to 6% of the relevant property value, it may appear modest on paper. In practice, however, it is frequently more expensive than it first seems, for a straightforward reason: the cash to meet the charge must come from somewhere, and in most cases it has to be extracted from the underlying company. That extraction, whether by dividend or otherwise, is itself subject to tax, typically income tax in the hands of the trustees. The effective cost of the ten-year charge therefore needs to be grossed up to reflect the tax cost of extracting the funds. On a high-value trust holding an investment company, the real burden can be considerably greater than the headline 6% suggests, and this must be factored into the initial planning decision rather than treated as a manageable afterthought.
CGT and Investment Companies: The Overlooked Exposure
CGT is easily overlooked when the asset being transferred is an investment company. For both trading company and investment company shares, CGT holdover relief is available on a transfer into a discretionary trust, for trading company shares via s.165 TCGA, and for investment company shares via s.260 (which applies because the transfer into trust is a chargeable lifetime transfer for IHT purposes). Put simply, having an IHT charge is what makes CGT holdover possible for investment company shares. However, when making outright gifts of shares to an individual, the position is different. If shares in a trading company are transferred, holdover relief under s.165 remains available. In contrast, for an investment company, no holdover applies, the full CGT gain crystallises. In every case involving an investment company, the CGT consequences must be worked through before, not after, any decision is made on the IHT structure.
Freezer and Growth Shares
Both FICs and discretionary trusts can make use of freezer and growth share structures, though the FIC typically lends itself more naturally to this approach. The principle is the same in either case: founders hold fixed-value “freezer” preference shares, locking in the current value of their estate for IHT purposes, while “growth” ordinary shares, issued to or for the benefit of the next generation at nominal value, capture all future appreciation (above a “hurdle” value). Because the growth in value accrues to the growth shares from the outset, it falls outside the founders’ estates without any further transfer of value being required. In the context of a FIC in particular, this is a powerful tool for freezing IHT exposure at the current generation level while allowing wealth to accumulate free of IHT for the next, without triggering either a Chargeable Lifetime Transfer (CLT) or a Potentially Exempt Transfer (PET) on the future growth element.
The Critical Definitional Divergence: Trading for IHT vs CGT
The IHT and CGT definitions of trading diverge materially. For BPR, a company qualifies if it is “wholly or mainly” a trading business: HMRC treats this as more than 50% of assets, income or activities being trading in nature. For CGT reliefs, including s.165 holdover and Business Asset Disposal Relief, the test is that the company must not carry on non-trading activities “to a substantial extent,” which HMRC interprets as no more than 20%. A company with 30% investment assets may therefore secure BPR for IHT purposes while simultaneously failing every CGT relief, leaving a transferor exposed to an unrelieved CGT charge at the point of settlement into trust.
Conclusion
Post-April 2026, the discretionary trust should not be treated as the default succession planning vehicle. For trading businesses, the more efficient route in many cases will be a direct gift of shares as a potentially exempt transfer, combined with a claim for s.165 TCGA holdover relief to defer any CGT. This avoids the relevant property regime entirely, eliminates the ten-year and exit charges, and produces no immediate tax cost on either IHT or CGT. The trust may still have a role where control, asset protection or flexibility for the trustees is paramount, but the tax cost of maintaining it, particularly the ten-year charge and the additional tax burden of extracting funds from the underlying company to pay it, should weigh heavily in that decision.
For investment assets, the FIC with a properly structured freezer and growth share arrangement is likely to be more attractive than a discretionary trust in most cases. Freezing the founders’ estate at current value and allowing all future growth to pass to the next generation without any transfer of value sidesteps both the entry charge and the periodic charges that make the trust route increasingly costly over time. A gift of investment company shares out of a FIC will attract CGT with no holdover available, but the freezer structure avoids the need to make such a gift at all in respect of future growth.
The common thread in both scenarios is that the ten-year charge is a material and recurring cost that is easily underestimated, and that CGT, particularly for investment companies, must be at the centre of the analysis from the outset. Careful consideration of all the alternatives will in many cases point away from the discretionary trust and towards a combination of direct gifting and a well-structured FIC.