Overview of a Family Investment Company
A family investment company is a popular vehicle for succession planning, wealth preservation and inheritance tax (“IHT”) mitigation. Frequently used as an alternative to trusts, it allows family members to invest collectively in assets such as shares, cash or rental property. It is a tax-efficient vehicle for accumulating wealth for the long-term benefit of a family, particularly dividend income, which generally rolls up tax-free within the company. There are no IHT entry or periodic charges, unlike with most trusts.
Such an entity is set up as a UK company, typically unlimited as statutory accounts do not generally need to be filed at Companies House. This means, however, that shareholders are liable for the company’s debts on an insolvency.
Funding the Family Investment Company
The family investment company is funded by way of a subscription for shares in exchange for cash. On setting up the company, the founder can gift shares to his children, and any such gifts fall outside his IHT estate after seven years.
The founder may also make a loan to the company. This provides the advantage that funds can be extracted from the company gradually through repayment of the loan. Alternatively, he can gift the loan notes to the children.
Shareholders can hold different share classes, allowing dividends to be paid to family members. However, there is a risk that His Majesty’s Revenue and Customs (HMRC) may invoke the settlements legislation if it takes the view that income is being artificially diverted to lower-rate taxpayers.
Control
The founder can retain control by holding shares carrying a voting majority. These rights carry significant value for IHT, even in the absence of capital or dividend rights. For that reason, instead of holding shares with enhanced voting rights, the founder is likely better served to retain control by virtue of being a director of the company, with many shareholder powers being subject to his consent as director, as stipulated in the Articles of Association and shareholders’ agreement.
Dividends Roll Up Tax-Free
A key benefit of holding investments in a family investment company is that the dividends it receives are generally exempt from corporation tax. Other income and gains are subject to corporation tax within the company, generally at the rate of 25%, and further tax is payable by the shareholders when the proceeds are extracted by way of dividends or ultimately on a liquidation. It is therefore advantageous to roll up income within the company, reinvest it within the company, and only distribute it for personal allowances or if the family needs it.
Minority Discount
For shareholders with minority holdings, a significant discount can be applied on death for IHT, to reflect the difficulty of selling a minority holding, and their restricted rights as shareholders. This is one of the biggest advantages of the family investment company structure.
Divorce
Family investment companies offer some element of asset protection on a divorce, as the Articles of Association are drafted such that shares cannot be transferred to non-family members (including ex-spouses), and there are compulsory transfer provisions whereby the divorcing shareholder is bought out by the other shareholders.
The assets of the company are generally beyond the reach of the family court. Having said that, the value of the shares will be taken into account on the divorce, though their value is negotiable, and will include a minority discount.
Concluding Remarks
To sum up, family investment companies offer the possibility of IHT mitigation, gross tax-free roll-up of dividends, and a corporation tax rate of 25% (as compared with up to 45% for individuals or trusts). The founder can retain control over company decisions and pass down the economic value in a phased manner.
In 2019, HMRC set up a specialist team to look into whether family investment companies were being used for tax avoidance and found no evidence of non-compliance; as such they remain a popular vehicle for succession planning.
