Five Mistakes to Avoid When Setting Up a Family Investment Company

The idea behind a Family Investment Company (FIC) is sound. When one goes wrong, it is usually because of small choices made early, often in the wrong order or by advisers who were not talking to each other. These are five we see most often, with the fix for each.

1. Putting cash straight into the company

Many people assume that giving money to a company they own is much the same as giving it to the family. For inheritance tax it is not.

A potentially exempt transfer must be a gift to another individual, or to certain trusts for disabled or bereaved minors. A company is neither. So a cash gift to a company that reduces your estate is a chargeable transfer from day one. It uses your £325,000 nil-rate band, anything above it can be charged at 20% during your lifetime, and a further charge can follow if you die within seven years. Paying more than shares are worth, or waiving a loan, has the same effect.

The fix. Choose the funding route on purpose. Parents can give cash to adult children, which is a potentially exempt transfer, and the children then take up shares. Or the parents can lend to the company and subscribe for shares at full value. Or assets can be moved in once the tax consequences have been worked through.

2. Overlooking the rules for children under 18

Giving shares to a young child feels natural. The tax rules are less friendly. If a parent gives shares, or the cash to buy them, to an unmarried child under 18, the gift is a settlement. Dividends on those shares are taxed on the parent unless they come to £100 or less in the tax year. Once they pass £100, the whole amount is taxed on the parent, not just the excess.

The rule catches settlements by a parent only. Gifts from grandparents are generally outside it, unless the arrangement is reciprocal or the parents supply the money. HMRC reads the whole arrangement and not just the paperwork.

The fix. Plan for minors from the outset. Options include a trust, genuine gifts from grandparents, or waiting until the child turns 18. Separate share classes are a sounder way to direct dividends than dividend waivers, which HMRC can challenge as settlements.

3. Keeping a benefit from shares you have given away

The point of passing on growth is that the shares leave your estate. A gift with reservation of benefit brings them straight back, and it arises where you keep any benefit from what you gave.

HMRC's examples include a gift made on condition that the donor becomes a salaried director with a car and other perks, and a gift where the donor holds an option to buy the shares back. Director's pay that was already being received on commercial terms is not a problem, and a parent voting the shares in the beneficiaries' interests is not in itself a reservation.

Treat this as a risk to manage. Control alone is not usually a benefit and arm's-length directors' fees are fine, but control combined with any benefit from the gifted shares needs care.

The fix. Settle who is paid what, and why, before any shares are given. Keep the arrangements commercial and recorded. In a structure that includes a trust, make sure the settlor and spouse are properly excluded.

4. Assuming the company pays 19%

A common assumption is that a FIC pays corporation tax at 19%. For most it does not. A company that mainly holds investments is a close investment-holding company and pays 25% on all its taxable profits, whatever the amount. It cannot use the small profits rate or marginal relief.

The practical tax can still be modest, because most UK and overseas dividends received are exempt, and the charge falls on interest, rent and gains. But a plan built on 19% is wrong from the start. Only a FIC that mainly lets property commercially to unconnected tenants, or mainly holds trading companies, can use the lower rates. Letting to family does not count. Remember too that the thresholds for the lower rates are shared between associated companies.

The fix. Run the numbers at 25% on investment income and gains.

5. Treating governance and protection as an afterthought

A FIC is a real company. It needs a director who is an individual, minutes for its decisions, accurate statutory books and annual filings. The accounts of a limited company are public and the people with significant control appear on a public register.

The documents carry as much weight. The articles and shareholders' agreement decide who may sell shares, what happens on divorce, bankruptcy or death, and who holds the votes. Without them, shares can leave the family in ways nobody wanted.

A well-built structure can help protect family wealth. Articles can restrict transfers and require a sale on divorce or bankruptcy, growth shares can be non-voting, a discretionary trust can hold some of the shares, and a pre-nuptial agreement is worth encouraging. None of this is a guarantee, because family courts can take trust and company interests into account and insolvency law has its own reach.

The fix. Decide the governance and protection points at the start, and have the documents drafted to match the tax advice.

Getting the order right

The simplest way to avoid all five is to plan the whole structure before acting, then move in sequence: funding, share classes, any trust, governance, and only then the gifts.

You can read more on our Family Investment Company service page, or see how the two options compare in our post on trusts and Family Investment Companies.

This article is general information, not advice. If you would like to talk through your plans with our specialist team, book a call. Our advice is prepared by our specialist team and reviewed by a Chartered Tax Adviser, and your first call is free.

To explore Family Investment Companies further, visit our specialist practice, Family Investment Company.