UPDATED 27/8/21

IT IS ANECDOTALLY REPORTED that due to the pandemic, birth rates are expected to rise. With estimates for children’s education to cost over hundreds of thousands, can setting up a trust for the benefit of children not only help save tax but also assist with child education costs?

In this article Shipleys Tax Advisers takes a look at some of the traps and pitfalls of the recent trend towards planning for school fees and why professional advice is key to achieving the correct outcome if you want to avoid an expensive HMRC challenge.

YOU SHOULD NOT ACT (OR OMIT TO ACT) ON THE BASIS OF THIS ARTICLE WITHOUT SPECIFIC PRIOR ADVICE. SHIPLEYS TAX PLANNING PROVIDES A BESPOKE TAX CONSULTANCY SERVICE AND CAN ADVISE YOU OF THE RIGHT COURSE OF ACTION.

Bank of (grand)Mum and Dad

Generally, the most common method we come across is the so called “grandparent solution”. This typically involves transferring shares/assets to the grandchildren (usually minors) held via a type of trust arrangement. The idea being that the beneficiaries (e.g. grandchildren) in these circumstances being minors are unlikely to have other income, the trust arrangement allows them to use their annual tax-free allowances such as the personal allowance, savings rate allowance and dividend allowance.

The idea being that beneficiaries (e.g. grandchildren) in these circumstances are likely to be minors and are unlikely to have other income, the trust arrangement allows them to use their annual tax-free allowances…

This is a seemingly a reasonable solution for grandparents who wish to transfer shares/assets to the grandchildren where the donor is not a basic rate taxpayer or where the donor wishes to reduce the value of their estate for inheritance tax (IHT) purposes.

Sorted, you would have thought.

Well not quite, there are significant pitfalls which need considering.

Is the income taxed on the minor? 

The major problematic issue is that the income may not be treated as taxable on the minor. This type of scenario is not straight forward and requires careful scrutiny of the settlements legislation and to ensure that there are no direct or indirect reciprocal arrangements in place.

Where parents are setting up trusts for their minor children anti-avoidance legislation can tax any income arising on the parents, so this method may not be tax efficient or indeed even work. In other words, there is a significant health warning with this planning which many are unaware of.

Gift of shares 

In other situations, where the adult gift interests in their business to their parents and these are subsequently given to the minor/s in quick succession, the transaction will be at a serious risk of a successful HMRC challenge which will result in the income being taxed on the parents. 

Where parents are setting up trusts for their minor children anti-avoidance legislation can tax any income arising on the parents, so this method may not be tax efficient or indeed even work.

If, however,  the transaction occurs whereby the asset is held by the grandparents with no onward obligation/intention that the asset will be transferred to the minors, and the shares are held for a reasonable period of time (i.e. where the probity of ownership cannot be in issue) and where all conditions are met, or perhaps due to a change of circumstances, the grandparents of their own volition decide to genuinely gift the asset to the minors, this should not be subject to a successful challenge by HMRC.  So, in reality it’s all a question of genuine intention and timing. Getting this right along with the surrounding facts and circumstances, then the prospect of having a successful fees planning increases. However, allowing assets to pass to the grandchildren via the grandparents as part of pre-arranged set-up will undoubtedly fail and will be subject to a successful HMRC challenge.

Sale of shares

In circumstances, where the grandparents acquire an interest in the parents’ business for full market value for/on behalf of the grandchildren, the anti-avoidance provisions do not apply. However, one will need to be mindful that the full open market is actually paid and there are no reciprocal arrangements in place.  The cost of this may be prohibitive due to the costs of asset, valuation and other professional fees.

However, allowing assets to pass to the grandchildren via the grandparents as part of pre-arranged set-up will undoubtedly fail and will be subject to a successful HMRC challenge.

COVID-19 Gifting income producing assets – a timely opportunity?

The grandparents could gift/acquire an income producing asset for the benefit of the minors and hold these on trust. This would typically be a bare trust – as opposed to a substantive trust mainly due to compliance and costs. However, this comes with a significant risk as minors (as beneficiaries) will have absolute entitlement and control of the business at the tender age of 18. The parent/grandparent may not wish for the minor to control these assets at such a young age.

It is said that a discretionary trust or an interest in possession trust may therefore be a more appropriate solution here due to its flexibility and control, and, unlike a bare trust, beneficiaries are not entitled to the assets of the trust upon attaining 18 years.

However, the tax anti-avoidance provisions apply here also. If the parents set up the trust with the intention to fund school fees, then a discretionary trust may not be a tax efficient option.

As such, if income producing assets, for example stocks, shares or investment property, is rightfully gifted/acquired by the grandparents for the benefit of minors, the income would be taxable on the minors and could go towards paying for their private school fees.  

…if income producing assets… can be gifted/acquired by the grandparents for the benefit of minors, the income would be taxable on the minors and could go towards paying for their private school fees.

With COVID-19, the valuations of income producing assets may be at a value which allows gifting without significant capital gains tax consequences, perhaps a timely opportunity? 

HMRC Radar 

We have been told that a small minority of school fee planners have aggressive schemes in implementing school fees planning. Currently this appears to fall under HMRC radar as it is not straight forward for HMRC to connect the dots with this planning. However, this does not mean this will continue forever – with the burgeoning big data revolution HMRC as poised to invest in IT systems to enable them to fill the gaps much quicker than they are now.

As such, school fees planning should be based on sound principle and careful thought; a matter of good advice not a matter of good fortune.

YOU SHOULD NOT ACT (OR OMIT TO ACT) ON THE BASIS OF THIS ARTICLE WITHOUT SPECIFIC PRIOR ADVICE. SHIPLEYS TAX PLANNING PROVIDES A TAX CONSULTANCY SERVICE AND CAN ADVISE YOU OF THE RIGHT COURSE OF ACTION.

If you are interested in School Fees Tax planning advice, please call us on 0114 272 4984 or email us at info@shipleystax.com.