Family Investment Company Pros & Cons

A family investment company can be an attractive approach to tax and succession planning.

In this guide, we look at what family investment companies are, the tax advantages available, as well as how these companies work and are managed. We also look at the overall benefits and drawbacks of a family investment company to help individuals decide if this is the best way forward for their family’s future.

 

What is a family investment company (FIC)?

 

A family investment company (FIC) is a corporate structure used for investment purposes, and even though this type of bespoke tax planning vehicle has been around for decades, it has become an increasingly popular and tax efficient alternative to a family trust.

An FIC is essentially a private company whose shareholders are family members, typically different generations of the same family, allowing taxpayers to pass on their wealth to children and grandchildren by way of shares in that company.

The investments in an FIC will typically comprise either equity portfolios or property, where the company invests rather than trades. The company will often be set up by either a parent or parents, with the founder(s) transferring cash or assets into the company, usually by way of a loan, and bringing in family members as shareholders on creation or at a later date.

 

What are the tax advantages of an FIC?

 

There are various tax advantages when it comes to family investment companies, including inheritance tax, capital gains tax and income tax savings.

First and foremost, the family investment company can be an extremely effective tax planning vehicle when it comes to mitigating any liability to inheritance tax (IHT) on death. If assets are held personally, in an individual’s own name, these will form part of that person’s estate on death, where IHT is typically payable at a rate of 40% on anything over and above the basic nil rate band of £325,000. However, provided the FIC is properly structured, and subject to the seven-year survivorship rule, any money and property held in an FIC will fall outside the deceased’s estate when calculating any liability to IHT.

This means that after seven years, the value of the money or property transferred into the FIC will fall outside of the founder’s estate for IHT purposes, provided they do not retain any beneficial interest in the company. In this way, the future growth in value of company assets can also be removed from the founder’s estate. Over time, the assets in the company will potentially increase in value, but this financial growth will reside in the company shares, and in the hands of the next generation, rather than accumulating a liability to IHT.

While family trusts remain a popular choice for parents and grandparents in the context of estate planning, helping to protect the wealth of future generations, FICs can be far more tax efficient than traditional trust arrangements when it comes to IHT. This is because there will not be the initial inheritance tax charge of 20%, introduced by the government on most lifetime settlements in 2006, on anything exceeding the nil rate band of £325,000.

In addition to the IHT benefits, any profits arising from the investments of the FIC will be taxed at corporation tax rates (just 19%) rather than the higher rates of income tax (up to 45%) or capital gains tax (up to 28%), making FICs an attractive option for tax and succession planning.

 

How does a family investment company work?

 

A family investment company can work in various different ways, but will usually involve the creation of different classes of shares with different rights. The founder’s shares will typically carry voting rights, but no rights to dividends or any return on capital, while the other class(es) of shares will be distributed to family members, who will have a right to capital and income, and either limited or no control over the company and its assets.

Any founder is usually both a shareholder with voting rights and a director of the FIC, in this way giving them control of the company at shareholder and board level. This will allow them to pass on their wealth for future generations, with all of the various tax benefits that go with this, while retaining control over the company during their lifetime.

However, the structure of a family investment company is flexible, with considerable nuances in how the company can be set up, where it can be tailored specifically to each family, dependent upon the assets and individuals involved. It can even include trust ownership of shares in circumstances where this is likely to lead to additional tax savings.

This means that bespoke articles of association and shareholders agreements must be carefully drafted at the outset to regulate who can make what decisions, such as what assets the company invests in or what dividends are paid and to whom, as well as what happens when the founder or other shareholders die, or when other eventualities occur. For example, articles can be set up to include specific clauses that protect the shares in specified circumstances, by restricting shareholders to immediate family, in this way preventing shares from being transferred outside of the family on divorce.

The governing documents must therefore be specific to the family investment company being set up, and the family dynamics, including clear provisions covering directors appointments, the distribution of profits, return of capital and share transfer provisions.

 

How to manage a family investment company

 

Any founder of a family investment company is typically appointed director(s), where the other shareholders cannot usually make decisions about investment strategy or the payment and timing of any dividends, but they will able to benefit financially.

The company, under the control of the founder(s), will then acquire assets which generate a return. Income can either be re-invested within the company and/or used to repay the founder’s loan, but any underlying capital value grows in the names of future generations.

However, the way in which an FIC is managed, both strategically and on a day-to-day operational level, will again depend on the specific articles of association and shareholders agreements drawn up for the company. As these are often tailored to the individual needs of the founder and their family members, the variations involved are potentially vast.

 

Pros of a family investment company

 

There are various benefits to setting up a family investment company, including:

Unlike the traditional family trust arrangement, there will be no upfront IHT charges where, with careful structuring, any assets held in an FIC will fall outside the founder’s estate on death, in this way facilitating the preservation of wealth for future generations;

It is a tax efficient way to maximise and hasten the accumulation of private wealth, where profit from the founder’s investment will be subject to the lower corporation tax rates, rather than the higher rates of income tax and capital gains tax for assets held personally;

The founder can maintain control over how their wealth is protected, including investment decisions, the payments of dividends and the transfer of shares, including what happens in the event of severance from the family, such as on divorce and death;

There is flexibility as to how an FIC is set up, from the types of shares and conditions attached to these, to the types of assets that can be held in the company;

There are also other practical advantages when compared with family trusts, for example, the director(s) can choose to take greater investment risks than a trustee might be comfortable with, as trustees have to abide by trust law.

FICs can therefore offer an ideal way for families with wealth to invest in their future, and to transfer that wealth to subsequent generations, while protecting and growing the company’s assets in a structured way. In short, a family investment company can enable high net worth individuals to retain control over assets, while accumulating wealth in a tax efficient manner and facilitating future succession planning.

 

Cons of a family investment company

 

Despite the initial attraction of the benefits offered by a family investment company, there are also various drawbacks to the FIC as a tax and succession planing mechanism, not least the complexity and costs involved in setting up a company designed to meet the unique needs of the founder(s) and their family. This is because there are many possible strategies when using FICs, with various different practical, legal and financial implications. Setting up an FIC will also require the services, and often the close cooperation of, several different professionals, including tax planners, accountants, lawyers and financial planners.

When considering whether a family investment company is the right option, the founder and their advisors must take into account all kinds of different considerations including divorce and death of founders; divorce of family members; adding new family members; the inclusion of minors; drawing income from assets personally; and the tax implications on the transfer of certain assets — and this list is by no means exhaustive.

A family investment company may also not be appropriate if income from assets is required personally by the founder, or if the founder is planning on regularly distributing the income of the company to their family. This would have negative tax implications, resulting in both corporation tax and income tax liabilities than if the asset was held directly. FICs work best for those with a substantial amount of money to invest, £1million plus, who are willing to retain their investment in the company to grow, rather than taking it out on a regular basis. As a tax efficient structure to hold and grow assets for future generations, the focus of an FIC is typically on investment and growth, rather than the payment of dividends.

 

How to set up a family investment company

 

The structure and strategy of a family investment company will vary depending on the circumstances of the founder(s), although common considerations include:

 

The introduction of assets

The founder of the FIC will usually either gift or loan assets to the company, but this will depend on the nature of those assets and any tax implications on transfer. In all cases, anyone thinking about setting up a family trust will need to consider how much they are going to invest in the company and what assets the FIC itself will invest in, and whether these are existing assets or new assets. This could be anything from property, equity securities, artwork and even classic cars.

 

The type of company

Consideration must also be given as to whether the FIC is set up as a limited or unlimited company. The main difference is that unlimited companies are not required to file accounts at Companies House, in this way retaining privacy over the family’s wealth. However, unlimited companies do not have the benefit of limited liability for shareholders, which may potentially be an issue if the FIC goes on to invest in trading businesses or the disposal of assets in the future.

 

The different classes of shares

The types of shares to be issued to the founder(s) and their family members, and whether these shares will have associated voting rights attached to them, is one of the key considerations when setting up an FIC. The type of share distribution will not only determine the level of control that each individual can exercise over the company, but also the distribution of income and assets. The idea is usually that the value arising from the growth of assets held in the FIC are passed to the future generations, rather than retained by the founders, thereby minimising exposure to IHT.

However, the short answer as to how a family investment company should be set up, is always with specialist tax and legal advice. Importantly, following a recent review by HMRC as to the use of FICs as an inheritance tax planning vehicle, although no compliance issues were raised, new anti-avoidance rules created for FICs in the future cannot be ruled out.