- Churchill Tax
Children – Tax Planning
Funding the university years
Supporting your youngster while they’re living away from home and studying at university is expensive. Usually you would have to fund this out of taxed income, but to improve tax efficiency can you divert some of your income directly to them?
Diverting income
The Taxman’s attitude to shifting income is often misunderstood. In most situations he has no objection, even where you save tax. He will allow you to give away assets unless you or your spouse can still benefit from the income they generate or you’re giving the assets to your child. In these situations he has special anti-avoidance rules to cancel any tax advantage.
The university years
However, when your youngsters turn 18 the anti-avoidance rules no longer apply. But how much tax could be saved by shifting income to them?
EXAMPLE:
Bill expects to have to find £9,000 per year to pay for accommodation and living expenses for his son while he’s at university. Funding this from his company dividends will cost Bill £2,250 in extra tax each year. But if he gave his son enough shares in his company, Acom Ltd, to produce annual dividends of £9,000, this would be entirely tax-free.
Structuring the gift
Bill isn’t keen on his son owning shares in Acom. Instead, his idea is to create a new company (Newco) of which he’ll own most of the shares and his son the rest. Some of Acom’s admin functions will be taken over by Newco, for which it will charge Acom a management fee at commercial rates. The profit Newco makes will be paid out as a dividend to his son. Not only does this save Bill £2,250 income tax per year, Acom also receives a Corporation Tax deduction from its profits for the charges paid to Newco.
TIP:
Bill can waive his dividend in Newco meaning there will be more in the pot to distribute to his son in the event that profits can’t be maintained in later years. It’s best that Bill waives his dividend well in advance, but less than a year.
Pros and cons
This scheme works well because Newco is isolated from Acom and so Bill’s son can’t benefit from higher dividends if it makes bumper profits. Plus, the level of income, and thus dividends, can be more easily controlled by varying, within reason, the level of management fees Newco charges. The trouble is, the cost of setting up and running Newco will take a bite out of Bill’s tax saving. Although as he has two more children this makes the scheme more viable as they could also be made shareholders.
TIP:
A simpler and cheaper option is for Bill to create a different class of share within Acom. These can be non-voting ordinary shares so that Bill retains full control of Acom. It then pays dividends on the new shares at a different rate than the ordinary shares. This means that Bill can set the income level for his son simply by varying the rate of dividend on the new shares.
Can anti-avoidance apply?
HMRC isn’t keen on these arrangements, but set up properly there’s not much it can object to. Whichever option you choose, we recommend getting help from your accountant to make sure that it’s set up correctly.
Conclusion
You can transfer assets and the income they generate to anyone aged 18 or over without triggering anti-avoidance rules. For example, you can create a new class of share in your company for your children and pay dividends directly to them while they’re at university. This can save you 22.5% or more in tax.