02 August 2017
How to fund private school fees tax efficiently
Business owners who are paying private school fees for their children’s education often ask if there is a more tax efficient way of structuring their affairs to meet this cost.
This is a common problem among successful business owners, one that I have been asked about by several clients over recent months. As parents and business owners, the level of salary and dividends you’d need to draw from your company to cover private school fees on top of normal living costs, will inevitably lead to large personal tax bills.
Is there another way? Could your children hold shares in your company and then be paid dividends which are covered by their (currently unused) personal allowances and dividend allowances? In theory this could allow each child to receive up to £16,500 per annum currently in dividends, completely free of tax, with those funds then used to meet ‘their’ school fees. Even dividends above that level would attract 7.5% tax, compared to much higher rates in the hands of the parents.
However, as you can probably guess, it isn’t that simple. If a parent transfers shares to their minor children (i.e., aged under 18) then the parental settlement rules apply. These rules treat the gift of shares to the child as a ‘settlement’ in which the parent will be the ‘settlor’. Where the rules apply, the ‘settlor’ is taxed on the child’s income as if it were their own, scuppering any potential tax benefit.
The parental settlement rules apply where the parent is directly or indirectly involved in any arrangements designed to provide dividend income to their children. As a result, gifting shares to grandparents that in turn gift those for the benefit of their grandchildren are also caught, since the parent would be deemed to have indirectly provided the funds for their children.
Having said that, selling (or making a fresh issue of) shares in your company for full market value to grandparents that they pay for entirely out of their own resources, with no reciprocal or other arrangements, would not be caught by the parental settlement rules. Those shares could then be transferred (either directly or via a Trust arrangement) to the grandchildren, with future dividends taxed on the children, as set out above, and then used to meet their school fees.
A simple bare trust would allow the grandparents to hold the shares on behalf of the grandchildren until they reach 18, and the dividends would be taxed on the children, since HMRC recognise them as the beneficial owners of the shares under this type of arrangement.
Alternatively, the shares could pass into a discretionary trust for the benefit of the grandchildren which is a more robust structure and would usually avoid the children becoming outright owners of the shares when they reach 18. While this is a far more complicated and costly Trust, essentially the same income tax benefits can apply.
In summary then, where a grandparent is willing to purchase shares in your company for full value, which they will then gift to the grandchildren, dividend payments made against those shares would be taxed on the children, making use of their tax-free allowances, and those funds can then be used to meet the school fees.
Clearly there are other factors to consider here beyond tax alone, but in principle these type of arrangements can be highly tax effective, if implemented carefully.
If you would like further advice on this matter then please contact me.
- A minor child (<18) is entitled to a tax-free personal allowance and dividend allowance
- Dividend income of £16,500 per child could be received tax-free and used to pay school fees
- But if the parent is directly or indirectly involved with gifting shares to the kids it’s ineffective
- The parental settlement rules tax the parents on the children’s dividends
- Grandparents could buy shares (for full value) and gift to grandchildren (or into trust)