School fees dividend diversion scheme doesn’t work

Paying for private education is a top priority for some parents, it is often seen as the best way to set your children up for future success. However, HMRC has given its views on an avoidance scheme which seeks to reduce or avoid tax on income used to pay private school fees – the arrangements are marketed as tax planning and targeted at owner-managed companies. HMRC’s view is that the schemes do not work.

Spotlight 62: Dividend diversion scheme used to fund education fees

In spotlight 62 HMRC describes a six point structure of the scheme

The arrangements, which are marketed as tax planning, seek to avoid tax by allowing the director-shareholders to divert dividend income from themselves to their minor children.

The arrangements work as follows:

A company issues a new class of shares which usually entitles the owner of the shares to certain dividends and voting rights.
Person A, usually a grandparent or sibling of the company owner, purchases the new shares for an amount significantly below market value.
Person A usually gifts the shares to a Trust or declares a trust over the shares for the benefit of the company owner’s children.
Person A, or the company owners, vote for substantial dividend payments in respect of the new class of share.
This dividend payment is paid to the trustees of the trust.
As the beneficiaries of the trust, the company owner’s children are entitled to the dividend.

The company owner’s children pay tax on the dividend received. They pay much less tax than if the company owners received the dividend due to the children’s personal allowance, dividend allowance and basic rate band.

Some estimates suggest that these arrangements could save a family with three children in private school up to £60,000 of tax per year.

HMRC’s view is that this, and similar schemes, do not work as the arrangements are caught by the Settlements anti-avoidance legislation.

Scheme promoters are required to comply with the Disclosure of Tax Avoidance Schemes (DOTAS) legislation and may be subject to penalties if they fail to comply.

This legislation requires a scheme to be disclosed where all of the following apply:

it has one or more defined “hallmarks”
it is expected to provide a tax advantage
that advantage is one of the main benefits for the users of the scheme.

What should I do if I am in one of these schemes?

HMRC is likely to send ‘nudge letters’ to those they have suspicion may have been participants in these arrangements.

If you are in one of these arrangements and/or receive a nudge letter, you should speak to a professional adviser at the earliest opportunity. An adviser can help make a disclosure to HMRC or by managing an enquiry. If you haven’t already received a nudge letter from HMRC then we advise you take a proactive approach and disclose the matter to HMRC rather than waiting for the inevitable to happen.

What should promotors do?

If a firm has promoted this scheme they need to disclose the fact to HMRC. It is irrelevant whether the firm has successfully sold the scheme to a client, where it has been promoted, it must be disclosed.

Promoters will be liable to a penalty if they fail to disclose a scheme to HMRC within 5 days of the scheme being made available or implemented. The initial penalty is up to £600 a day. If this is not considered to be a sufficient deterrent, promoters may have to pay a penalty of up to £1 million.

Alternative ways to pay school fees in a tax efficient way

The cost of school fees are rising and, its understandable that parents and family members may be looking for alternative ways to pay school fees in a tax efficient way.

Simple but effective planning options include:

Investing in Venture Capital Trusts (VCTs) – dividend income received from VCTs is exempt from income tax, which can then be used to fund school fees. In addition, 30% income tax relief on up to £200,000 of a qualifying investment is also available.
Investing in a qualifying life assurance policy – investors can take up to 5% tax-deferred withdrawals from the policy, which can be used to help fund school fees. Depending on the nature and terms of the life assurance policy, there can also be associated inheritance tax benefits for the policy holder.
Making use of your children’s junior ISA allowance (£9,000 p.a.) – allows you to invest funds to help pay for future fees. Or use the returns (income and capital) that are tax free from your own ISA allowance (£20,000 p.a.) to help fund the cost of school fees.

There are also more complicated structuring options that involve family members:

The grandparents have their own company. They issue shares to the children (via a trust) to fund their education.
A relative (Grandparent/Aunt/Uncle) gives valuable shares to a child. The child pays tax on the dividends at a much lower rate, and there’s a big tax saving.
Rather than giving the shares to the child, the relative declares a trust. They may in fact need to do this, because minors can’t hold shares. If it’s a simple or “bare” trust then the tax result is the same as if the child owned the shares.

It is essential for individuals and firms to remain vigilant about compliance with tax regulations and seek expert advice to ensure their financial arrangements are lawful and proper. By adhering to the tax laws and making use of legitimate tax planning strategies, families can navigate school fees in a responsible and legal manner.

MD and Tax investigation specialist talks about dividend diversion and school fees over on Tik Tok

If you have children and private schools and would like to discuss tax efficient ways to help with school fees then please get in touch

Other articles that can relate to avoidance schemes and dividend diversion can be found here

Tax Avoidance Schemes – Do fines deter promotion?

Have avoidance schemes gone toxic?

Promoters of Tax Avoidance Schemes

dividend diversion