If you’re seeking to pass your assets onto the younger generation, there are various options available with family investment companies becoming increasingly popular. Family trusts on the other hand are falling out of favour, with figures from HMRC showing that numbers have nosedived over the last 10 years.

This decline has mainly been driven by government policies, specifically Gordon Brown’s announcement in 2006 that all lifetime settlement, with a few exemptions, would be subject to a 20% initial inheritance tax charge if the amount transferred into a trust, exceeded the individual’s available nil rate band (£325,000).

But although the tax rates have changed, don’t be too quick to dismiss a family trust in favour of a family investment company. There are pros and cons which need to be assessed before you make your decision.

Benefits of family companies

In simple terms, if you set up a family company, you put cash or assets into that company, create different types of shares in your company and give the shares that hold the capital value of the assets to your children.

To enable you to keep control over the assets in the company, you can be named as a director and be a preferential shareholder, so you have all the voting rights but no rights to the capital. If you adopt that approach, as long as you keep no beneficial interest in the company, then after seven years, the value of the money or property transferred will fall outside of your estate for inheritance tax purposes.

There are also tax advantages, including relief for interest paid on mortgages. Furthermore, profit from your investments will be subject to the lower corporation tax rather than the higher rate income tax.

Importantly, transferring cash into a family company is not subject to the initial inheritance tax charge of 20% if it exceeds the available nil rate of £325,000. Therefore it is an appealing option for people if they want to transfer funds in excess of £325,000 to their children, whilst maintaining control of them.

Disadvantages of family companies

An important factor to consider is that the government is not afraid to change tax law. This may seem like an area bound by strict rules, but it is reviewed and changed frequently. If the government starts to shine a spotlight on family companies this could lead to another shakeup. If the law is changed, and changed retrospectively, this would catch many people out.

To minimise the impact of this potential risk, make sure you review the structure of your family company regularly with your lawyer to keep up to date with any legal changes.

Another issue often overlooked is the high cost of setting up a family company. Lawyers, including corporate solicitors as well as accountants will need to be involved and this can lead to lots of initial charges.

Bear in mind, that if you’re putting a property into the company rather than cash, this could result in capital gains tax and there is potential stamp duty to consider. If you’re planning on regularly distributing the income of the company this would have a negative tax implication. The only way to get money out is through dividends, this would lead to you paying both corporation and income tax which together would be higher than if the asset was held directly.

How do I know what’s right for me?

Family companies work best for those with a substantial amount of money to invest (£1m plus) and who are willing to keep it in the company to grow, rather than take it out on a regular basis. They’re also a good option for those who want to avoid a large inheritance tax charge and retain control over their assets, especially if their children are younger.

As an alternative, family trusts provide an accepted and arguably safer structure, which doesn’t have the same initial charges to establish.

In some cases, it’s also worth considering an outright gift. Although this offers no control or protection over your assets, it may be appropriate for those seeking a simpler way to pass their wealth onto older and responsible children although possible inheritance and capital gain tax should be considered.

Ultimately, the decision should be based on your individual circumstances and advice from a lawyer and accountant. Take time to assess your options and don’t be too swayed by the growing popularity of family companies. They have their benefits but there are risks too, so weigh up both the pros and cons before you pursue.