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Family investment companies (FICs) are becoming a more frequent topic of conversation when clients speak to us. While they do not yet enjoy the same level of familiarity as trusts, growing awareness, coupled with changes to the tax treatment of trusts, has led many individuals and families to consider how FICs might fit within their wider planning.
FICs can, in the right circumstances, offer tax and succession planning advantages. However, their suitability will depend on the profile of the assets to be transferred into the FIC, as well as the relevant objectives and family dynamics.
Structuring a FIC
A FIC is, at its simplest, a private company, typically incorporated in the UK, that is owned and controlled by members of a family. The company is then used as a vehicle to hold investments that might otherwise be owned personally.
In most cases, members of the senior generation will act as directors and retain strategic control over the company, while shares are held by family members. The company then invests, with returns accruing to the company and ultimately benefiting family shareholders.
FICs are usually established with specific planning objectives in mind, allowing the rights attaching to different share classes to be carefully tailored. This flexibility is one of their principal attractions.
Multiple share classes can be created, with varying entitlements to income, capital and voting rights allowing a balance to be struck between passing economic value to the next generation and retaining appropriate control.
FICs as tax wrappers
From a tax perspective, one of the key drivers is the difference between personal and corporate tax rates. Investment income received personally can be subject to income tax at rates up to 45%, whereas company profits are currently subject to corporation tax at 25%.
Depending on the nature of the underlying investments, a FIC may also benefit from dividend exemptions and reliefs on disposals of certain "substantial" shareholdings. These mechanisms mean that, in certain best-case scenarios, return on the underlying investments can be received by the FIC without triggering corporation tax (or triggering very little), leaving more funds to reinvest or distribute.
In addition, the structure tends to be most tax efficient where there is no immediate need for shareholders to extract income and investment proceeds can instead be retained and reinvested within the FIC. The payment of dividends introduces an additional layer of taxation at the shareholder level. Accordingly, in a year in which dividends are paid, both corporation tax and personal dividend tax may be incurred, potentially resulting in a combined effective tax rate of up to 55%.
One of the attractions of an FIC is that, as a general principle, the making and repayment of loans between shareholders and the company should not give rise to a taxable event. Accordingly, loans used to fund an FIC can provide a relatively efficient means of extracting value prior to the payment of dividends.
That said, the tax position of FICs can be nuanced depending the taxpayer's precise circumstances. The principles outlined above are overlaid by a number of complex and technical rules, which may present potential pitfalls if not carefully managed.
FICs as estate planning tools
In the UK, reducing inheritance tax (IHT) exposure often involves passing value to the next generation during lifetime. A FIC can facilitate this by enabling value to be transferred through shares with defined economic rights.
Typically, FICs are structured so that growth in the underlying investments accrues to shares held by younger family members. This is achieved through the creation of different share classes, allowing the senior generation to retain control through voting rights while passing economic value to their children or grandchildren.
Control by the senior generation can also be retained through board representation. This enables the senior generation to influence key decisions, such as whether and when distributions are made, while still making a meaningful transfer of value for IHT purposes. Shareholder agreements can also be used to regulate how and when value is realised.
Although the economic value retained by the senior generation may be limited, it is not eliminated entirely, as control rights themselves have value.
Suitability of FICs
FICs will not be appropriate in all cases. They are generally most relevant for individuals with surplus capital who are comfortable with a long-term investment horizon and with passing future growth to the next generation.
They are less suitable for assets intended for personal use, such as residential property, and the costs of establishing and maintaining the structure need to be considered alongside the anticipated benefits.
International considerations are also important. For example, FICs are often not suitable for US-connected individuals due to the operation of the Passive Foreign Investment Company regime, in relation to which alternative structures may be preferable.
Timing is also a relevant factor. Implementing a FIC at an earlier stage allows future growth to accrue within the structure. By contrast, transferring existing investments that stand at a gain into a FIC may trigger capital gains tax at the point of transfer.
Overall, FICs can form a valuable part of a broader wealth planning strategy, combining elements of tax efficiency, succession planning and governance. However, careful structuring and ongoing advice are essential to ensure that the intended objectives are achieved and that risks are reduced.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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