Why family investment companies are better than trust structures for UK tax

Choosing the right vehicle is crucial when considering how best to manage and protect family assets, particularly in the UK. Traditionally, family trusts have been the preferred option, but in recent years, family investment companies (FICs) have become a more beneficial structure for many families. This article will explore why FICs are increasingly preferred over trusts, focusing on the tax benefits, flexibility and control they offer.

Understanding Family Investment Companies (FICs)

A Family Investment Company (FIC) is a limited liability company created to manage and control family assets. The business is owned by family members, who may be shareholders, while the family itself usually serves as the board of directors. The main objective of a FIC is to invest in assets such as stocks, real estate and other investments aimed at generating wealth for the family.

Main characteristics of family investment companies:

• Limited liability: Like any private company, the liability of shareholders is limited to their investment.
• Control: Family members typically make up the board of directors, allowing them to maintain control over investment decisions.
• Share structure: Different classes of shares can be issued to family members, providing flexibility in income distribution and, importantly (from an IHT perspective), capital appreciation.

Trust Structures: An Overview

Trusts have been a traditional method of managing family wealth and assets for generations. They involve a grantor transferring assets to trustees, who manage the assets for the beneficiaries.

Main characteristics of trusts:

Separation of ownership: Legal ownership is separated from actual ownership, which can provide protection and flexibility.

• Trustees: Trustees have the legal responsibility to manage assets in the best interests of the beneficiaries.
• Beneficiaries: Individuals or groups who benefit from the assets and income of the trust.

Tax Considerations: Family Investment Companies and Trusts

Tax efficiency is often the main concern when choosing between a family investment company and a trust. Below we look at the tax benefits of FICs and Trusts that make FICs more attractive overall.

1. Corporate tax and income tax

Family investment companies:

Corporation tax: FICs are subject to UK corporation tax on their profits, which from 2023 is levied at 25% (increased from the previous rate of 19%). This rate is often lower than the highest income tax rates (currently 45%), making FICs potentially more tax efficient.

Dividend Income: Dividends received by a FIC are generally exempt from corporation tax, allowing for more tax-efficient income streams for the company investing in stocks and shares.

Trusts:

Income tax: Trusts are subject to income tax at rates of up to 45% for discretionary trusts, which can be significantly higher than the corporation tax rate.

Dividend income: Trusts may be taxed on dividend income, resulting in potentially higher overall tax liabilities than FICs.

2. Capital gains tax

Family investment companies:

Indexation allowance: Although removed for individuals, FICs benefit from the indexation allowance on assets held before January 2018, which can reduce the taxable gain on the sale of assets.

Corporate capital gains tax: capital gains within a FIC are subject to corporate tax (25%) rather than capital gains tax -values ​​of individuals which could be subject to an increase.

Trusts:

Currently lower CGT rates: Trusts are subject to capital gains tax, with rates of up to 24% on residential properties and 20% on other assets. These amounts are lower than the current corporate tax rate of 25%.

Annual exemption: Trusts benefit from an annual exemption from CGT compared to companies which do not, meaning that some of the gains within a trust are exempt from tax.

3. Inheritance Tax (IHT) planning

Family investment companies:

Donate shares: Family members can donate shares in the FIC, potentially reducing the value of their estate for inheritance tax purposes. The value of the business, rather than the underlying assets, is taken into account for IHT.

Control without ownership: Parents can maintain control of the business without owning significant shares, thereby minimizing the taxable value of their estate.

Trusts:

Immediate IHT charges: Transfers to trusts may trigger immediate inheritance tax charges if they exceed the available nil rate band.

10-year anniversary fee: Trusts are subject to periodic fees, known as a 10-year anniversary fee, which can erode asset values ​​over time.

4. Flexibility of income distribution

Family investment companies:

Classes of shares: FICs can issue different classes of shares to family members, thereby allowing flexible arrangements for income distribution and profit sharing.

Dividends: Dividend policies can be tailored to each family member’s tax situation, thereby optimizing overall tax efficiency.

Trusts:

Rigid distribution: Trust income distributions may be less flexible, particularly in the case of discretionary trusts, where trustees must consider the needs of beneficiaries and may face higher tax rates on distributed income.

Accumulation: Trusts can accumulate income, but this may result in higher tax liabilities due to accrued rates.

Control and governance

1. Asset Control

Family investment companies:

Directing control: Family members acting as trustees retain control over investment decisions, asset allocation, and strategic planning.

Flexibility: FICs allow families to adjust their strategies and make decisions quickly in response to changing circumstances.

Trusts:

Trustee Control: Trustees have fiduciary responsibilities and control over assets, potentially limiting the family’s direct influence on decisions.

Formal processes: Changes and decisions often require formal processes and compliance with the provisions of the trust deed, which can be cumbersome.

2. Governance and accountability

Family investment companies:

Transparent reporting: As businesses, FICs must comply with company law, particularly in terms of filing accounts and maintaining transparency.

Responsibilities of directors: Directors are accountable to shareholders and ensure that governance is consistent with family interests.

Trusts:

Duties of the Trustee: Trustees are responsible to beneficiaries but may have discretion over distributions and investments.

Limited transparency: Trusts often lack the transparency and regulatory requirements that govern FICs, which can lead to less accountability.

Practical considerations

1. Configuration and administration

Family investment companies

Company formation: Setting up a FIC involves standard business formation processes, including articles of association and issuing shares.

Administrative burden: FICs require regular accounting, compliance with company law and potential audit requirements.

Trusts:

Trust Deeds: Establishing a trust involves drawing up a trust deed, appointing trustees and ensuring compliance with the Trusts Act.

Ongoing Administration: Trusts require ongoing administration, including filing taxes and meeting trust obligations.

2. Financial implications

Family investment companies:

Setup Costs: The initial setup costs of a FIC may be lower than those of establishing a trust, particularly if complex trust structures are involved.

Ongoing costs: FICs may incur costs related to business administration, accounting and compliance.

Trusts:

Higher setup costs: Establishing a trust, especially a complex trust, can involve significant legal and advisory fees.

Trustee Fees: Trustees may charge fees for their services, which are in addition to the ongoing costs of managing the trust.

3. A wealth that stands the test of time

Family investment companies:

Adaptability: FICs can adapt to changing circumstances, allowing families to adjust their strategies as needed.

Succession planning: The ability to issue shares to younger generations facilitates smooth estate planning and wealth transfer.

Trusts:

Rigid Structures: Trusts may be less adaptable to changes, with fixed terms and conditions that may not match changing family dynamics.

Generational Challenges: Trust structures can struggle to accommodate multiple generations, particularly as families’ needs change over time.

Conclusion

Family investment companies (FICs) offer an attractive alternative to traditional trust structures for managing and preserving family wealth in the UK. With favorable tax treatment, enhanced control and flexibility, FICs offer a modern solution that meets the dynamic needs of today’s families.

While trusts have their place, particularly in estate planning and asset protection, FICs offer distinct advantages that make them an attractive choice for many families looking to optimize their wealth management strategies.

Next step

As with any financial decision, it is essential to consult professional advisors to determine the best approach for your particular situation. Do not hesitate and contact ETC Tax to discuss any of the above points.