Trusts have always been the vehicle of choice for families that have wanted to ring-fence wealth for future generations. They enable assets to be passed on to the next generation whilst retaining control, and importantly they can prevent assets being lost if future generations are affected by divorce. Trusts also used to be very tax efficient but this has changed in recent years. Putting cash and most other assets into a trust above the available nil rate band (currently £325,000) will trigger an immediate tax charge at 20 per cent. Since 6 April 2010 the trust income tax rate is 50 per cent. These tax charges have made trusts less attractive for wealthy clients.

What is a Family Investment Company?

A Family Investment Company (FIC) is a private investment company designed to mirror many of the features of a discretionary trust. As it is a company, it is very flexible. Share rights can be tailored to meet clients’ specific needs, for example, enabling income to be paid only to one shareholder, or at different rates to different shareholders.

Control of the FIC rests with the board of directors and their powers are largely similar to trustees of a trust. The board will determine the investment policy of the FIC and will have control of when and if income is paid to shareholders. Shareholders’ rights can be restricted to protect the control of the FIC and the constitution of the company generally.

To protect privacy, an FIC is likely to be formed as an unlimited company as this entitles the company to an exemption from filing accounts at Companies House.

Tax treatment of an FIC

A FIC is an investment company, so it will suffer two levels of tax as profits – made up of income and gains – are subject to corporation tax (generally at 28 per cent), and tax is also payable when those profits are extracted. Since 6 April this year, the maximum impact of this double charge is an effective tax rate of 54 per cent. At first sight this suggests a FIC is not a tax efficient structure, but that is not the case where the intention is for income to be accumulated.

For example, if £100 was invested at an annual interest rate of 5 per cent in a FIC, at the end of five years, the FIC would have £137.48 after paying tax annually at 28 per cent. If the same investment was made in a trust suffering a 50 per cent annual tax charge, the trust would have just £124.89. The funds in the FIC will have grown 12.59 per cent more than in a trust. This extra growth more than compensates for any additional tax payable when the income is extracted.

But a FIC can be even more tax efficient: for example, dividends received from other UK companies and most offshore companies are not subject to corporation tax. Accordingly a FIC can easily work positively to invest income that rolls up tax free.

It is worth noting that capital gains are taxed in the same way as income within a FIC, so they will also suffer tax at 28 per cent. This does not compare well to the 18 per cent paid by a trust, but a FIC can claim indexation allowance which reduces the effective rate over time. It is also widely anticipated that the 18 per cent capital gains tax rate will be increased, possibly to 25 per cent or even 30 per cent. If that happens of course, a FIC will look even more attractive.

Estate planning

The payment of inheritance tax is something that most families would prefer to avoid. As a result it makes sense to pass wealth down the generations where at all possible. A FIC makes this easy, as investments are pooled and a share in the FIC is then gifted as appropriate. This avoids having either to choose which assets should be given to which beneficiary, or dividing ownership between a number of beneficiaries.

Another benefit worth noting is that when a shareholding in a FIC is valued, a discount can be applied to take account of the size of holding. The reduced value will of course mean that less inheritance tax is payable if the shareholder dies than if they had held a direct interest in each of the assets owned by the FIC.

Asset protection

Protecting assets, particularly on divorce, is a major concern for clients and it is perhaps in this area that FICs are particularly useful. The case of Hashem v Shayif & Another (2008) is a significant case dealing with corporate structures in family proceedings. A family owned company was central to the litigation and the family court was asked to make orders against the company to transfer company assets to the wife. Several different arguments were put forward but the judge refused to pierce the corporate veil – its separate legal personality - and instead made clear that a court can only look behind the corporate structure to the people controlling the company if there has been some impropriety linked to the company. The judge did not believe that legitimately taking advantage of a corporate structure involved any impropriety. Accordingly, no order was made against the company even though to do so appeared to be in the interests of justice.

It is important to note that in the case of Hashem the judge did emphasise that this was a properly formed and managed company (for example, appropriate board minutes were maintained). To ensure maximum protection is available, it is vital that a FIC is also properly established and operated. It is also possible to increase protection, for example, the company’s articles should restrict the identity of shareholders to prevent a family court ordering a transfer of shares.

A FIC can be better than a trust for asset protection, as a FIC formed by a party to a marriage during the marriage is still able to offer protection against divorce, whereas a trust established in that situation would be characterised as a nuptial trust and exposed to the courts’ wide powers to make orders against it. This does not mean, however, that the value of the shares will not be seen as a resource but the key is that the assets are protected. In practice the courts allow time and flexibility on how any settlement is reached.

Summary

FICs enable families to pool investments, pass on wealth down the generations, retain control, keep taxes to a minimum and protect wealth. A FIC is therefore a very attractive alternative to a trust, particularly to a family worried about the wide discretion of the family courts to redistribute assets in the event of a divorce.