Family Investment Companies – Your questions answered

Jason Varney, a Partner in our Corporate &Commercial team, and Amy Lane, a Senior Associate in our Estates, Tax & Succession team discuss Family Investment Companies .

Jason, what is a Family Investment Company?

A Family Investment Company or FIC is a bespoke private company which is usually set up as a tax efficient alternative to a family trust.  It is essentially a company that holds assets and investments, which allows the wealth to accumulate within the company in a tax efficient way; as well as providing flexibility for future asset protection and succession planning. The FIC is usually set up with cash (be that a gift or a loan) rather than transferring other assets which could trigger tax liabilities, such as capital gains tax and stamp duty land tax.

What does a Family Investment Company do?

The FIC operates as an investment company rather than a trading company.  Normally, investment managers are instructed after the FIC has been set up to manage the investments the company holds and advise on when money can be paid to shareholders by way of dividends.

Who controls a Family Investment Company?

Control on a day-to-day basis is with the board of directors, who are usually the same people that set up the FIC. The board are responsible for making company decisions, such as what investments the company makes and when dividends are paid to shareholders. Normally, the founders also subscribe for voting shares in the FIC, which gives them control of the FIC at both a shareholder level (due to their voting shares) and at board level (due to being directors).

Who are the shareholders of a Family Investment Company?

As I mentioned earlier, usually the founders (the people who set up the company) hold the majority of the shares which allows them to make decisions at shareholder level by majority.

Shares with non-voting or minimal voting rights are often given to the next generation i.e. children or grandchildren as a means of transferring wealth. The next generation will be able to receive dividends if they are declared, or capital if the FIC is wound up. Their lack of voting rights (if they are issued non-voting shares) or minority shareholding (if they are issued voting shares, but fewer than the founders hold) prevent them from outvoting or overruling the founders. For example, if parents set up a FIC where all shares had voting rights, we would suggest the parents retain a collective 51% of the total voting shares. This enables them to mostly block any proposal at shareholder level that goes against their interests or vision of the FIC’s direction.

Alternatively, the parents may want to give their children a higher proportion of the voting shares but control how they are exercised in certain circumstances using a shareholders’ agreement. For example, a shareholders’ agreement may prevent the shareholders from voting to appoint directors without the prior consent of the all of the other shareholders.

The founders can also control how different family members benefit from the profits of the FIC by assigning them different classes of shares with different rights attached to them (sometimes referred to as “alphabet shares”. This provides the founders with flexibility when making payments to their family through dividends.

What is the purpose of creating a Family Investment Company for estate planning , Amy?

Generally, the aim is for the founder of the FIC to reduce the value of their estate by making gifts to their children and grandchildren. Either they will subscribe for shares in the FIC themselves and gift them to family members, or they will make cash gifts to their family who will use the money to subscribe for shares in the FIC themselves. As long as the founder survives seven years from the date of making the gift, the gift will fall outside of the founder’s estate. Additionally, any profits generated by the FIC can be retained or distributed directly to the shareholders of the FIC, thereby reducing the amount of growth that stays within the founder’s estate.

There are also other, non-financial, benefits to a FIC. For many clients, the structure of a FIC provides a controlled environment for the founder to introduce their children (and potentially grandchildren) to the job of managing the family’s wealth. Their involvement may start with their role as shareholder, but they may eventually be appointed to committees, or even to the board.  For instance, it allows for those with a lower rate income tax bracket to benefit when dividends are issued (which can then be used for school fee payments).

Are Family Investment Companies useful for asset protection in the context of divorce?

Yes, they are.  Both FICs and trusts provide useful protection, although FICs are slightly different.  With a FIC, the company can be structured so that only direct family members can hold shares in (and therefore receive dividends from and exercise control over) the FIC. Additionally, the Articles of Association – which can be thought of as the internal governing rules of a company – may prohibit the transfer of shares to a non-permitted persons e.g. the spouse of a family member, or even prevent a compulsory transfer of the shares on divorce. This means that in the event of a divorce, the Court generally wouldn’t order the transfer of shares in a FIC to a divorcing spouse, because the Articles of Association do not permit the transfer. However, the Court could of course permit a transfer of other assets in a shareholder’s sole name to their divorcing spouse or civil partner to compensate them for their inability to award shares in the FIC. Although not relevant to the context of the divorce, it is sometimes beneficial for the spouses of children of the founders to be able to benefit through a trust structure to avoid a tax charge on their child’s death (if their child is married or in a civil partnership).

Who is a Family Investment Company suitable for?

Given the costs involved in setting up and maintaining a FIC, they are only worthwhile for individuals who are looking to invest a large amount of money into the FIC, typically amounts in excess of £1 million. FICs are intended to be used for long-term, rather than short-term investments, given the difficulty of paying out capital as opposed to regular income through dividends, so FICs are best aligned with those who have long-term investment / planning goals.

Why might you use a Family Investment Company rather than a trust?

Done correctly, setting up a FIC won’t trigger an immediate inheritance liability, whatever the initial sum involved, whereas a transfer of cash or other assets into a trust might. An individual can only transfer assets into a trust up to the amount of their nil-rate band allowance (currently £325,000) tax free in any seven year period. Beyond this limit, an immediate tax liability of 20% would arise on the value above £325,000. For instance, if I set up a FIC with £1m cash, there wouldn’t be an immediate tax charge, whereas if I transferred £1m into a trust, I would trigger an immediate tax liability at the rate of 20% on the £675,000 in excess of £325,000 (i.e. £135,000).

The ongoing tax rates applicable to FICs are much more favourable, at least for now, compared to trusts. FICs are subject to corporation tax (currently 25%) whereas the rate for trusts is 45% for savings income and 39.35% for dividend income, although with trusts, lower rate taxpayers get a credit on the tax paid by the trust which can be claimed back from HMRC.

Another thing that is quite different with FICs is that, unlike trusts, they will not pay tax (or be assessed for tax) every ten-years or when capital is distributed. Trusts, by comparison, are subject to tax at 6% on the market value of all the assets they hold, minus any allowable reliefs and exemptions, every ten years. As FICs are often intended to provide for several generations of a family, this can amount to a significant tax advantage. As such, an individual may choose to invest further sums into their FIC long after it is first incorporated.

An additional feature of a FIC that is worth mentioning is the discount in valuation it may attract. Where the founder chooses to retain a minority shareholding in the FIC, the valuation of that share for inheritance tax purposes may be reduced significantly to take account for the fact that they have less control and power over the FIC. This may reduce the amount of inheritance tax payable by the founder’s estate on death.

I suspect the rules applicable to both  may well feature in the Autumn Statement but at the moment, FICs are generally more tax efficient for larger transfers of cash than trusts, although the costs of setting up a FIC are more than trusts.

 Are trusts still useful?

Absolutely.  Trusts are a key part of planning for a lot of our clients and, although their rates of tax are generally higher than FICs, the rate can sometimes be lower depending on the assets within the trust.

Trusts may also have a role in FIC planning as well. They can be used as a tool for the founder to divest themselves of a larger proportion of shares by gifting some to a trust which they act as trustee of (and therefore control the voting of), thereby retaining control of the FIC at shareholder level. Shares held in a trust may also be useful for a founder to one day transfer shares to benefit people who do not exist yet, for example future grandchildren.

So, if you want to set up a Family Investment Company, what do you need to do to get started Jason?

This is where we link in with Amy’s team to discuss how those shares pass on death; to ensure the Wills are consistent with the Articles of Association to allow the transfer of shares on death in the correct way.  It’s also often quite useful for Amy to link in with the children of the parents too, to ensure the shares their parents assign to them are dealt with correctly. You also need to give some thought to who the initial shareholders would be and also the name of the company which will then be registered at Companies House.  The initial meeting generally involves someone from both our teams to agree the main terms and points.

For more information about FICs, you can reach Jason and Amy on the following:-

Jason Varney – 01892 701269 / jason.varney@ts-p.co.uk

Amy Lane – 01892 701366 / amy.lane@ts-p.co.uk