Pros and Cons of a Family Investment Company

A FIC is a private limited company established to hold investments for a single family, to manage the family’s wealth, preserve assets, and potentially pass wealth down to future generations through the transfer of shares in that company.

It is a planning structure that can be used to transfer wealth to other generations while maintaining control over the assets comprising that wealth without creating an immediate inheritance tax (IHT) charge.

Advantages of Family Investment Company

FICs offer numerous advantages for individuals and families looking to manage and preserve their wealth including enhanced control, flexibility, and tax planning opportunities. Let’s explore some of the advantages of FICs:

Corporation Tax Savings

Initial funding for a FIC can come from the initial share subscription, share issues or loans. In our experience donors usually fund a FIC with a loan that can be repaid from post-tax profits free of dividend or income tax. Other family members are the shareholders of the FIC, with different classes of shares created to meet the needs of different family members.

The FIC can also make pension contributions to directors, who are family members, which are deductible for corporation tax purposes.

Sometimes shareholders of a FIC have shareholdings in other interests, such as a trading family business. These shareholdings can be introduced to the FIC, so the FIC has an investment in the trading business and, subject to qualifying conditions, if the trading company is sold, the proceeds received by the FIC in consideration for the sale could be 100% tax free. It is important to note that such an investment may require the FIC to be audited, if the investment in a trading company creates a group that breaches the UK audit thresholds.

Profits are taxed at a corporation tax rate of 25%, which is currently lower than personal income tax rates.

Inheritance tax savings

A FIC does not pay inheritance tax, but a shareholder will pay inheritance tax on the value of their shares in their estate subject to the nil rate band and spouse relief. The value of their shares may be discounted to reflect a minority interest. When shares are gifted, they may be treated as a potentially exempt transfer, and if so, there is no immediate charge to inheritance tax. The value of the shares will need to be within the donor’s nil rate band for inheritance tax to avoid an entry charge but, subject to that, any capital gain can be held over. If the donor survives seven years, they will fall out of their estate for IHT purposes.

If the FIC is funding via a loan (as referred to above) it should be noted that HMRC regard a loan which is interest free and repayable on demand as being made at market value, so there is no reduction in the value of the lender’s estate and no transfer of value for IHT. However, a fixed term, interest free loan is likely to be worth less than its amount, so that it represents a diminution in the lender’s estate for IHT, potentially giving rise to IHT.

Income tax savings

There are no restrictions on the class of assets in which the FIC can invest. UK dividends on equities can be received by the FIC free of tax (provided they don’t fall within certain anti-avoidance rules). Care should be taken if a FIC is investing in corporate bonds or other debt-based investments, as such investments may be taxed under the loan relationship rules which will mean that any growth in value over an accounting period will be subject to corporation tax

Income, usually paid in the form of dividends, can roll up tax-free inside the company, as no income tax is payable until income is paid out.

FICs and divorce

Families tend to worry about wealth being lost due to divorce or due to bankruptcy or undue influence. The constitutional documents of a FIC therefore can include provisions that restrict the identity of shareholders, typically to bloodline descendants, and may extend to compulsory transfer provisions in situations where a shareholder is made bankrupt or in other ways fails to meet the expectations of the family. Whilst FICs cannot be ringfenced against divorce in so far as the value of shares in the FIC held by a divorcing spouse will be an asset that will be assessed as a marital asset for the purposes of any divorce settlement, restrictions in the constitutional documents may serve as a deterrent to the court to make orders in respect of the shares themselves.

Asset protection

By transferring assets into a FIC, individuals can separate their personal assets from their business and investment assets.

This separation helps protect personal wealth from potential risks associated with business activities, lawsuits, or creditor claims.

Control and governance

FICs allow families to retain control over their assets while involving multiple generations.

Through shareholding and directorship structures, family members can actively participate in decision-making processes and ensure the preservation of family wealth according to their shared vision and values.

Succession Planning

FICs provide a structured approach to succession planning, allowing families to pass on their wealth and values to future generations.

By establishing clear guidelines and governance mechanisms, FICs can facilitate a smooth transition of ownership and management, ensuring the family’s legacy is preserved.

Disadvantages of Family Investment Company

While FICs offer several advantages, it’s important to consider potential disadvantages as well.

Here are some factors to be mindful of when considering FICs:

Inefficient if all the profits are paid out

A FIC can be tax-inefficient if all the profits of the company are paid out to the family shareholders, as this can create the potential for double taxation.

At first, the company pays corporation tax on its profits, and secondly, the shareholders will have to pay Income Tax when profits are distributed in the form of a dividend to shareholders of FIC.
The FIC is thus more tax efficient if all the profits of the FIC are retained in the company.

Not effective if assets are transferred in the company

When assets other than cash are transferred into FICs, this may trigger a Capital Gain Tax charge, and if a property is transferred, this could also trigger a Stamp Duty Land Tax charge.

A transfer of cash is the best option to minimise the family’s tax exposure.

More administrative and expensive system

The cost of setting up the FIC and the ongoing administration, such as completing annual accounts, and corporation tax returns of FIC can make a FIC less attractive. In our view FICs are generally recommended for initial investments of more than £3 million.

Not suitable for families requiring regular returns

A FIC may not be appropriate if income from assets held by the FIC is required personally by the owners/founder or if the owner/founder is planning on regularly distributing the income of the FIC to their family members.

This would create negative tax implications, resulting in both corporation tax as well as income tax liabilities rather than if the asset was held directly by the individuals.

FICs are more suitable for use when holding large capital sums over the mid to long term and long term investments. The use of a discretionary trust may be preferable to hold smaller funds, assets that may be used by beneficiaries or for holding assets for beneficiaries not yet born or identified.

For a tax-efficient structure to hold and grow assets for future generations, the focus of a FIC is mainly on investment and growth rather than the payment of dividends.

Potential family conflicts

FICs can exacerbate existing family dynamics and potentially create conflicts among family members.

Disagreements may arise regarding the control, distribution, or management of the company’s assets. These conflicts can strain family relationships and impact the overall effectiveness and success of the FIC.

Lack of privacy

FICs are subject to certain disclosure and reporting requirements, which can compromise the family’s privacy.

Financial statements and other information may need to be made available to regulatory authorities, potentially exposing the family’s financial affairs to public scrutiny.

Certain investments are better held personally

Investments benefitting from tax incentives and reliefs such as the Business Asset Disposal Relief (BADR), Business Property Relief (BPR) or the Enterprise Investment Scheme (EIS), may be better off being made personally as the FIC would not be able to get the tax advantages available to individuals.

Legislative landscape

HMRC have, in the past, carried out some work to understand the use of FICs as an IHT planning vehicle concluding that “there was no evidence to suggest that there was a correlation between those who establish a FIC structure and non-compliant behaviours”. As a result, as at the date of this note, this has not led to any changes in the legislation affecting FICs, but it remains possible that, as with other vehicles used to transfer wealth, we could see changes in the future. Because of this, and also because of the complexities involved (including the mix of personal and corporate tax issues that need to be considered), appropriate advice should be taken before setting-up a FIC. Additionally, if you are thinking of changing the structure or operation of an existing FIC, we would always recommend taking additional professional advice before doing so.

Conclusion

In conclusion, FICs offer numerous advantages that can benefit families in managing and preserving their wealth.

These advantages include enhanced control, asset protection, succession planning, tax efficiency, wealth consolidation, flexibility in wealth distribution, investment opportunities, and confidentiality.

However, it is essential to consider the potential disadvantages associated with FICs.

These include the complex setup and ongoing administration, regulatory compliance requirements, risks of concentrated control leading to family conflicts, limited flexibility in capital withdrawal, tax considerations and changes in legislation, potential loss of personal ownership benefits, risks of family disputes and succession challenges, and reputational risks.

Ultimately, the decision to establish a FIC should be carefully weighed, considering the specific needs, goals, and circumstances of the family, and should be made in consultation with legal, tax, and financial professionals.

Thoroughly evaluating both the advantages and disadvantages will help families make informed decisions about whether an FIC aligns with their long-term wealth management strategy or not.

How ZEDRA can help

Our team of UK experts have considerable experience in providing advisory services for family investment companies. To find out more please contact one of our dedicated experts.

Disclaimer: Nothing herein shall constitute legal, tax or investment advice of any kind and ZEDRA accepts no liability for any reliance placed on the contents herein which are solely included for the purposes of marketing ZEDRA’s service offerings. Advice should be sought from appropriately qualified advisers to assess the suitability of any solution to your specific circumstances.