School Fees - Getting the planning right!

School fees continue to rise due to staff wage increases, property maintenance and heating and electric costs, in addition to the anticipation of VAT on school fees.

Many families are fortunate enough to receive assistance from grandparents with either surplus income, an inheritance or through tax planning. In all cases though, it is important to get the tax planning right in order to avoid a sudden, unexpected tax bill.

Where grandparents are paying fees out of income, consider the inheritance tax (IHT) planning. Any individual can give away up to £3K a year which is exempt from IHT, otherwise the gift will be chargeable if death occurs within seven years. An alternative is to ensure that:

• The gift forms part of the grandparent’s normal expenditure,
• is made out of income; and
• leaves the grandparent with sufficient income for them to maintain their normal standard of living.

In this case, the regular gifts could be exempt from IHT.

If the grandparent is paying higher rate tax on income received, and they have surplus income and capital, the grandparent could also consider giving the child an income producing asset so income tax is payable at the child’s tax rate, which could be lower. Advice would need to be taken regarding the capital gains tax (CGT) on the gift. Consideration should also be given to whether a trust should be used to protect the asset.

Often tax planning is undertaken to pass assets to minor children, or into trust for children, from which the income is used to finance school fees for the child. This planning is not income tax efficient if the assets are passed from the parent to the minor child – in most cases the income would remain taxable on the parent. However, if the grandparent gifts the asset, the future income arising could be taxable on the child.

Care is required to consider the CGT on the transfer. For those with family trading businesses, such as as farms, holdover relief could be available on the gain so that it is deferred to the later disposal of the asset by the child. For IHT purposes, the grandparent must survive seven years from the date of gift. However, if the assets qualifies for business property relief, then assuming the child retains the asset and they remain qualifying, IHT should not arise on a death within seven years.

Where the children are minors, often a trust is used so that control is retained by Trustees which could extend beyond the child turning 18 years old. The Trustees could be the grandparents or the parents.

Where trust income is used to pay for school fees, consideration needs to be given to the liability for the school fees. If the invoices are made out to the parents, then it is their liability to pay the school fees. If the trust income is used to settle the parents’ liability, then the income will be assessable on the parents. As such, any income tax planning to use the child’s tax free personal allowance, will be lost. The school invoices would need to be addressed to the minor child or the Trustees. An alternative is for the trust to make a one-off payment of capital to cover the fees for the whole time the child is at school.

There are anti-avoidance rules which, if they apply, instead of taxing the income on the child, will tax the income on the parents. The rules would apply if the parents gifted the company or partnership shares to their child or provided the cash for the child to purchase the shares. The rules could also apply where the dividends, or partnership profits, are voted by the parents – for example where the parents are the only directors of the company or have full power to vote the dividends or profit share.

The anti-avoidance rules would also bite where the parents provide the shares to the grandparents to gift on to the children, or where the grandparents make a new subscription for shares in the parents’ business before transferring to the children, or to trust for the children.

We are often asked whether the family company could pay for the shareholders’ children’s university fees, particularly if the child is doing a business-related degree. If the adult child is an employee of the company, the payment of fees could be part of their remuneration package and taxable as a benefit in kind. The fees could also provide a tax deduction for the business. However, care is required to ensure there is no argument that the arrangement is not commercial – if you would not enter this kind of remuneration package for another, similar employee, it is likely the benefit in kind would be taxable on the director parents.

It may be possible for the adult child to purchase shares in the family company. Assuming the company has sufficient retained profits, dividends could be voted on the shares to pay towards university fees. However, care is required to consider the anti-avoidance rules discussed above.

Finally, where a parent has previously loaned funds to their company, they could withdraw these funds to pay university or school fees tax free. Alternatively, they could charge interest on this loan, which may partly be within their tax-free savings allowance, and partly chargeable, but the net tax cost may be nil given the company will obtain corporation tax relief on the interest.

If there are insufficient loan accounts then the parents could borrow from the company and pay a commercial rate of interest on the loan. Alternatively, the company could pay tax on the overdrawn balance until the loan is repaid in the future.

In summary, great care is required if assistance with school or university fees is given by a grandparent or through a parent’s business. If you require advice or assistance with school fees please get in touch.

Many consider paying school fees in advance, particularly where they anticipate school fees increasing or VAT applying. Care should be given to paying school fees up front, particularly if this causes additional income and tax to be paid on that income to settle the fees. For example, I am aware schools are suggesting paying two years in advance. Assuming additional annual dividends from company shares are required to fund this, an income tax charge of 8.75% to 39.35% could arise.

If VAT does not get applied to school fees, does not come in until after that two-year period, the VAT rate is lower, or anti-forestalling rules are applied, then it may cost more in tax overall to pay up front.

It is also a good idea to review the school’s balance sheet to ensure there is little risk that it could fail resulting in a loss of the fees to other creditors. Also confirm that should the child wish to move schools the fees will be refunded.