Are family investment companies a good idea?

Family investment companies, usually referred to as FIC, are a company structure families use to create more favourable conditions, tax and otherwise, for passing on wealth to another generation.

FIC have gained in popularity recently, while other similar mechanisms, like family trusts, have fallen out of favour due to recent changes in tax legislation. This article will take a closer look at what FICs are and when and how they can most benefit a family.

FICs are structured so that the directors control investment decisions, but other family members can be shareholders. In most cases, the parents in a family are the directors, and the children are shareholders. Parents use this arrangement to pass down assets while still being able to control access to or use of those assets. In many cases, the directors have no access to the company’s capital but full control over all decisions with regards to it. If the company is structured correctly, assets held under this arrangement will not be subject to inheritance tax.

Most of the advantages of FICs centre on tax matters:

• The chief advantage of an FIC is protection against inheritance tax (IHT). The shares held by children in an FIC don’t count toward your taxable estate if certain conditions are met. While assets transferred into a trust are subject to an IHT if they are above the nil rate (£325,000 as of 2022), the amount that can be put into an FIC tax-free is unlimited.
• Tax savings: companies in the UK are currently subjected to a tax rate lower than that of income tax for individuals in high brackets, so the company structure can lower the tax bill of those who use it. FIC can also facilitate greater tax-free dividends than assets held directly just by one person: all shareholders over age 18 can receive up to £14,570, tax-free.
• FICs can be set up to provide a gradual transition of control so children can start taking the reins of investment decisions in a smoother, less drastic way.

FICs do have several potential drawbacks:

• if tax laws change in the future, the FIC could become a liability instead of a way to save on taxes as it is now.
• If a large portion of the FIC’s income/gains have to be paid out instead of being reinvested, this structure becomes less efficient because each shareholder would have to pay income tax on anything over their combined personal allowance (£14,570 for 2021-22). When this tax is combined with the corporate tax on the FIC, this sets up a double layer of taxation.
• FIC can have somewhat large upfront setup costs, as well as higher maintenance costs to ensure the entity’s compliance over time.

In essence, an FIC is just a private company, so the formal steps are the same as for any other company: choose a name, directors, and shareholders; draft the main documents like the memorandum of association and articles of association, and register the company.

However, there are specific considerations that need to be taken into account, especially in how the founding documents are drafted, in order to fully protect assets and reap the benefits of the FIC. These can include establishing different classes of shares to separate voting rights from rights to capital and income, as well as clauses to keep shares from leaving the family. Because of the complex and highly personalized nature of FIC, it is best to work closely with your accountant, tax advisor, and/or solicitor throughout the process.

The corporate tax rate (19% in 2022, although set to increase to 25% for some profit levels in 2023) applies to the gains and profits of an FIC. This is likely to be much lower than the taxes levied on individuals who hold assets directly (capital gains and income taxes). Also, dividends that are reinvested into the FIC are not likely to be subject to any tax at all, making the structure ideal for wealth accumulation.

Any gains the FIC makes are not part of the founder’s estate for inheritance tax purposes. The person who sets up the FIC can also give away the initial capital invested, which also becomes exempt from IHT after 7 years (unless that person dies first).