Children & Tax Planning

Diverting profits to pay university fees

If you’re considering long-term tax planning, you could do worse than transfer shares in your company to your children. But will this save tax despite HMRC’s tough anti-avoidance rules?

Diverting income

HMRC’s attitude to shifting income is often misunderstood. In most situations it has no objection, even where you save tax. It 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 it 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 you save 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 £2,925 (£9,000 x 32.5%) in extra tax each year. But if he gave his son enough shares in his company 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 his company. Instead, his idea is to create a new company, of which he’ll own most of the shares and his son the rest. Some of the old company’s admin functions will be taken over by the new company, for which it will charge the old company a management fee at commercial rates. The profit the new company makes will be paid out as a dividend to his son. Not only does this save Bill £2,925 (£9,000 x 32.5%) income tax per year, but the original company also receives a corporation tax deduction from its profits for the charges paid to the new company.

Tip. Bill can waive his dividend in the new company 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 the old company is isolated from the new one 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 his new company charges. The trouble is, the cost of setting up and running his new company 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 his new company. These can be non-voting ordinary shares so that Bill retains full control of his old company. 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.

For more info call us today on 0141 345 2335.

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