Setting up a family investment structure: will it be an OEIC, AUT or a FIC

Insight

23.03.2023

We are frequently asked to advise on putting in place legal structures to hold assets and investments. A key question is what is the most appropriate structure to use? The answer, as is often the case, is it depends on a number of factors and it may be that two structures are needed.

There is a broad choice of vehicles which can be used, ranging from offshore companies, trusts and foundations to onshore companies and trusts. In this article we focus on two UK structures first, an FCA authorised fund (either an open-ended investment company (OEIC) or an authorised unit trust (AUT)) and secondly a family investment company (FIC). The acronyms used can give an impression of greater complexity than is the case in practice.

We summarise below the key aspects of these structures and their differences. Of course, this is only a summary of the main features and is not legal advice.

We strongly recommend that anyone considering setting up such a structure takes specific legal advice.

What are OEICs and AUTs?

An OEIC is a corporate entity and regulated investment fund which is authorised and regulated by the UK Financial Conduct Authority (FCA). An OEIC is constituted under the Open-Ended Investment Companies Regulations 2001. An OEIC is a body corporate with separate legal personality and is the legal and beneficial owner of the assets of the OEIC.

An AUT is similar to an OEIC, in that it is a regulated investment fund, authorised and regulated by the FCA. An AUT is a type of unit trust constituted by a trust deed established pursuant to the Financial Services and Markets Act 2000 (FSMA). The AUT does not have separate legal personality and acts through the trustee or its delegates. The trustee of the AUT holds the legal title to the AUT assets for the benefit of its beneficiaries who are the investors.

Individual investors are shareholders in the OEIC/unitholders in the AUT, are entitled to receive distributions, or have distributions reinvested (depending on the share/unit class they hold) and the return of capital when they redeem their shares/units.

OEICs and AUTs are open ended funds. This means that they have variable capital and no fixed number of shares or units in issue. New shares/units in the fund are created in accordance with investor demand and any shareholder/unitholder has the right to sell their shares/units back to the fund at a price determined by reference to the net asset value of the fund’s underlying portfolio.

FCA authorised funds (including OEICs and AUTs), must be open to investment by others. An OEIC/AUT can however be set up for an initial group of investors who provide the seed investment with cash or via in specie transfers of assets.

As an FCA-regulated fund the OEIC/AUT must comply with applicable FCA rules and is subject to regulatory approval, oversight and scrutiny which brings with it certain benefits but also cost.

An OEIC or AUT in which retail investors can invest will normally be set up as either a UK UCITS or a non-UCITS retail scheme (NURS) fund. Although there are other types of authorised fund which some retail investors can invest in, these typically require a “genuine diversity of ownership” (GDO) condition to be met in order for the beneficial tax rules to apply to those funds. To meet the GDO condition a fund must be set up and managed to enable a diverse range of investors to benefit from the expertise of the investment manager and from the economies of scale that comes from pooling funds. An application can be made to HMRC for advance clearance that a fund meets the GDO and this is advisable for funds which must meet the GDO (for example the new Long-Term Asset Fund).

In practice, there is very little practical difference between the AUT and the OEIC apart from terminology. There is one potential tax benefit in respect of in specie transfers into an AUT, as mentioned further below (see here). For the purposes of the remainder of this briefing we refer to OEICs (rather than both OEICs and AUTs) unless there is a specific difference for the AUT.

What is a FIC?

A FIC (and for these purposes we consider only a UK structure) is simply a private company, established under the Companies Act 2006, which is set up for a family to hold their investments. The FIC will be registered at Companies House. The process of incorporation of a FIC is the same as for any private company and it is relatively quick and straightforward process.

Typically, a FIC is established as a private limited company, which ensures limited liability to shareholders. An unlimited company can also be used for the FIC which means that accounts do not have to be filed at Companies House and hence provides greater privacy regarding the assets of the investors. Where the anticipated investments to be held by the FIC involve risk, a limited company is normally recommended.

Individual investors are shareholders in the FIC and, subject to the rights given to shareholders in the constitutional documents of the FIC, are entitled to receive income by way of dividends and / or return of capital on disposal of their shares. Often the share capital of a FIC is designed to ensure that control and economic entitlement are separate, which allows a wider number of interested parties to be involved but with control vested in a smaller number. This may be part of a family succession or wider commercial arrangements. Specific tax advice, covering both the FIC and the personal tax of the shareholders, should be taken when putting in place different share classes.

What investment and borrowing powers apply?

The OEIC must comply with strict FCA rules on investment and borrowing (with slightly more flexible rules applying to the NURS than the UK UCITS).

The FCA rules are designed to protect consumers by requiring that the OEIC can only hold certain types of assets, typically liquid investments such as listed equities and bonds, cash and interests in other regulated collective investment vehicles.
Exposure to alternative assets, such as real property, commodities and alternative funds can be obtained but only to a limited extent and then mainly indirectly via exchange traded funds and other regulated collective investment vehicles. More esoteric assets are not permitted.
In addition, the FCA rules aim to ensure a diversification of risk, and include limits on how much of the portfolio of the OEIC can be invested in particular assets.
An OEIC is able to borrow up to 10 per cent in value of the OEIC's net asset value (if the OEIC is a UK UCITS this must be on a temporary basis only).

A FIC, in comparison to an OEIC, is much more flexible from an investment and borrowing perspective.

A FIC can invest in anything within the investment appetite of the directors and shareholders. The FIC can hold the assets which an OEIC can hold but can also hold, without restriction, private funds, real property, art, commodities, crypto, as well as other more esoteric assets.
For investors with large holdings of unlisted shares, an OEIC cannot be used, but a FIC can.
A FIC can also borrow to the extent considered appropriate by the directors/shareholders of the FIC.

Neither the OEIC nor the FIC is appropriate for holding investments which are to be used by investors, such as a residential holiday home. This is because for the OEIC it is unlikely to be an eligible investment and for the FIC any use by the investors of the asset could become taxable as a benefit in kind.

Can investment managers be appointed?

For both the OEIC and FIC investment managers can and typically are appointed to manage the assets of the structure. Such appointment will be recorded in an investment management agreement.

Considerable due diligence and oversight of such investment managers by the ACD is required in respect of the OEIC (see below click here).

What is the tax treatment of the vehicle?

A beneficial tax regime applies to FCA authorised funds. Under this regime:

there is no tax on capital gains within the OEIC provided those gains are from investment (rather than profit from trading transactions);
in respect of income, OEICs are, in principle, liable to corporation tax on any taxable income they receive at the basic rate of income tax (currently 20 per cent), however:

(a) no tax is payable on UK and non-UK dividends received by an OEIC (provided certain anti-avoidance rules do not apply). In respect of other income, in practice once expenses are deducted, there tends to be little taxable income remaining;

(b) if the OEIC has more than 60 per cent of its investments in debt instruments, it will be classed as a "bond fund" for tax purposes and taxed differently. Broadly, bond funds are still liable to tax on income, but are entitled to a deduction on whatever income they distribute to their investors (which in practice significantly reduces or extinguishes any liability to tax on income).
dealings in shares in OEICs are not subject to stamp duty or stamp duty reserve tax (SDRT);
due to a special exemption for authorised funds, there is no value added tax (VAT) on investment manager fees charged to an OEIC.

A FIC is subject to the UK tax regime for UK companies. This means:

where shareholders are comprised of directors and/or family members, the FIC is likely to be a "close investment holding company" and would automatically be subject to corporation tax at the full 25 per cent rate. Alternatively, where ownership of the FIC is more widely held and profits remain below the £250,000 threshold, the FIC should benefit from marginal relief to produce an effective corporation tax rate somewhere between 25 per cent and the small profits rate of 19 per cent. Standard deductions would be available to reduce the gain chargeable to tax (such as the acquisition cost of the investments and related expenditure);
no tax is payable on UK and non-UK dividends received by a FIC (provided certain anti-avoidance rules do not apply). However, FICs are liable to corporation tax on other income (including from trading activities) at the relevant corporation tax rate;
dealings in shares in FICs are typically subject to stamp duty or SDRT at 0.5 per cent;
VAT applies to investment manager fees charged to a FIC - there is no VAT exemption. This is likely to be an irrecoverable cost for the FIC.

How are investors taxed?

In respect of income, if the OEIC is not a bond fund (as explained above), investors will receive income from it by way of dividend distributions. In contrast, investors in a bond fund will receive interest distributions.

Dividend distributions are taxed in the same way as UK company dividends, UK resident individual investors are currently subject to tax on dividends from an OEIC at 8.75 per cent (for basic rate taxpayers), 33.7 per cent (for higher rate taxpayers) or 39.35 per cent (for additional rate taxpayers). No form of withholding tax is imposed in the UK on any dividend distributions paid by an OEIC.
Interest distributions are treated like yearly interest for tax purposes. This means that they are subject to income tax for individual investors (currently at 20 per cent for basic rate taxpayers, 40 per cent for higher rate taxpayers or 45 per cent for additional rate taxpayers).

In respect of a FIC, as it is a UK company, investors will receive income from a FIC by dividend distributions. UK resident individual investors are currently subject to tax on dividends at 8.75 per cent (for basic rate taxpayers), 33.75 per cent (for higher rate taxpayers) or 39.35 per cent (for additional rate taxpayers).

Individual investors will be subject to capital gains tax on any gain they make on a disposal of their shares in an OEIC or a FIC, and (subject to anti-avoidance rules) on a winding up of the OEIC or FIC and return of proceeds.

Investors may structure the vehicles such that the FIC is one of the investors in the OEIC, which can also bring with it tax benefits.

What about sources of funding?

An OEIC cannot be funded by way of loan due to the restrictions on its borrowing powers. It can be funded by way of cash or in specie subscription (if the assets provided by the investor are eligible assets for the OEIC under the FCA rules). In specie subscriptions to the OEIC will be a taxable event triggering a capital gains tax charge where there are unrealised gains.

There is a minor potential tax advantage of using an AUT rather than an OEIC where there is to be an in specie transfer of assets from an initial investor (or investors) to the AUT. This is because on the in specie transfer there is no change of the beneficial ownership of the assets transferred and hence no SDRT should arise. This is not the case for an OEIC, where the OEIC becomes the new legal and beneficial owner of the assets which are contributed. Subsequent in specie transfers will normally attract SDRT whether to an OEIC or AUT.

A FIC can be funded by way of cash subscription for shares or loan. Using a loan has some advantages:

Some investors prefer to fund the FIC via a loan to retain control of the initial capital sum used for investment by the FIC;
A loan also prevents a potential capital gains tax charge if the assets which would otherwise be transferred to the FIC include an investment portfolio or shares with considerable unrealised gains;
The loan route for a FIC can be tax efficient, funds may be extracted via partial repayment of the loan capital plus the interest charged on the loan (rather than by dividend). Tax would then be charged to the recipient investor on the interest element only.

Who runs the structure?

For both an OEIC and an AUT, authorised financial services firms must be appointed to hold key roles. These include an:

authorised corporate director (ACD) for the OEIC (manager for the AUT) responsible for the operating the OEIC/AUT; and
a depositary (trustee for the AUT) responsible for oversight and custody of the assets.

The OEIC has the advantage of independent authorised firms running and overseeing the operation of the structure, although this comes with the cost of those firms carrying out these roles.

A FIC is a private company, and must have at least one director (and can have more), who is legally responsible for running the company. A director, if a natural person, must be 16 or over and must not have been disqualified for being a director previously. A FIC will act through a combination of decisions made by the board of directors and resolutions of its shareholders. The shareholders will need to agree who can appoint board members and who else will be allowed to sit on the board.

What rights and control do investors have?

Individual investors in the OEIC are shareholders and as such have voting rights attaching to their shares in the OEIC, in accordance with the constitutional documents of the OEIC and the FCA rules. The FCA rules set out certain change events which require notification to shareholders or in some cases shareholder approval. The OEIC does however not allow founder shareholder rights to be embedded in shares (for example shares which bestow particular control rights over key matters).

Often a sponsorship agreement is put in place between the ACD and the investors in the OEIC setting out certain matters agreed between the investors and the ACD, for example, where the ACD needs to get consent from the investors. Although the sponsorship agreement is a private document and hence out of the public domain, it cannot cut across the ACD’s regulatory position as the entity which is responsible for running the OEIC. As such investors must accept the ceding of control of the running of the OEIC to the ACD.

For the FIC, the specific rules for decision-making processes and powers will be governed by the relevant provisions of the Companies Act 2006, the constitutional documents (articles of association) of the FIC, and any shareholders agreement (which is a private document), including the requirements for resolutions both at board and shareholder level, voting rights and meetings and quorum.

For both the OEIC and FIC, ultimately shareholders can decide (subject to any terms of the sponsorship agreement or shareholders agreement, as applicable) to wind up the structure and give instructions to the officeholders eg ACD and directors accordingly.

Can investors have different rights?

Authorised funds such as an OEIC can have different share classes, however the FCA rules provide that the shareholder rights of one class cannot provide an advantage that results in prejudice to other shareholders. The FCA rules specifically allow differences such as income or accumulation, or different fee levels. The FCA rules do not however permit greater voting powers, for example.

The FIC structure can be easily tailored to allow for different shareholder rights whether through the constitutional documents or through a shareholders agreement to provide for specific controls and rights. For instance, where appropriate, it is possible to create different classes of share for different investors (or groups of investors) so that individuals can be afforded different rights, for example, in respect of voting, receipt of income and return of capital, which would regulate the level of control over the FIC (and degree of benefit derived) by specific individuals. It is also common, particularly where broader interests are represented in the FIC, for the shareholders to impose restrictions on the board by the inclusion of reserved matters which require shareholder consent to material matters, such as investments, acquisitions or borrowing.

Provisions can also be included to cater for the appointment and removal of members of the board, so that the board could be selected according to which investors would be most able to deal with the day-to-day running of the FIC.

What about public registers?

The Financial Services Register, which is publicly available, will list the name of the OEIC, its type (eg NURS or UK UCITS) and the officeholders, which will be regulated entities (see above click here). Currently details of shareholders are publicly available. However, a register of shareholders of the OEIC must be maintained by the entity which has responsibility for maintaining the register (typically the ACD) and any shareholder of the OEIC has the right to view the OEIC register of shareholdings.

If the FIC is a private limited company, details of all directors, shareholders and persons with significant control (more than a 25 per cent interest, has the right to appoint or remove the majority of directors, or otherwise exercises significant control), will be publicly available via records held at Companies House.

What does the future hold?

HMRC did take an interest in FICs, however they recently disbanded their FIC unit indicating that their concerns have been allayed.

HM Treasury is currently undertaking a review of the UK authorised funds regime with the aim of making the UK a more attractive location to set up and manage investment funds with the possibility for authorised funds electing to be wholly tax-exempt under consideration. HMRC has recently made some changes to the GDO condition to allow certain vehicles to meet the GDO condition where part of a wider arrangement. These changes are not however directed at OEICs.

Investors across the generations may have differing investment priorities, with environmental, social and governance (ESG) factors a particular focus for some investors. The OEIC umbrella structure allows a number of sub funds to operate under the one umbrella structure and hence can facilitate investment where there is a different emphasis required for a particular feature amongst investors. For the FIC, separate subsidiaries under the parent company, would be needed.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.