Funding children’s school fees from an offshore trust

Setting the scene

A family of four – parents and two minor children – are discretionary beneficiaries of an offshore trust settled by the father’s uncle, who lived and died in Hong Kong many years ago. The trust has significant investment income and gains.

Both children attend private school. The father is a UK additional rate taxpayer with annual employment income of about £750,000. The mother is a homemaker. Annual school fees are £60,000 and wider household spending is around £100,000.

Because the father has high earnings, the parents have simply paid the school fees out of his taxed employment income and have tended to preserve the trust fund for the children and later generations.

The current cost

If the father funds £60,000 of school fees from earnings taxed at 45% with 2% employee NIC, that requires about £113,208 of gross employment income to leave £60,000 net.

Where the planning can help

If the trust makes income distributions to family members who are taxed at lower rates than the father, the overall family tax cost can be materially reduced. On the facts assumed here, the trust was settled by the father’s uncle rather than by a parent, so the note is not dealing with a parent-funded trust.

Illustratively, if trustees distribute £12,570 to each of the two children and to the mother, £37,710 is matched with three personal allowances. If the balance of the school fees – £22,290 – is then met by the father, the gross earnings needed to fund that balance fall to about £42,057.

If larger income distributions are made to the mother and children, the overall family tax rate can still be significantly lower than leaving all fee funding with the father. But that arithmetic only works if the distributions are taxed on the intended recipients.

The point that is often missed

For school-fee planning, economic benefit is not the only question. The legal liability for the fees matters.

If the parents are personally liable under the school contract and trustees simply pay the fees or reimburse the parent without any prior agency arrangement, HMRC may argue that the trustees are meeting the parent’s liability rather than providing the benefit directly to the child. In that case, the intended use of the children’s lower tax profile may be undermined.

That does not mean trustee-funded school fees can never work. The position is stronger where the trustees contract directly with the school, or where the parent signs only as agent for the trustees under a clear pre-existing arrangement that the trustees will bear the cost.

Practical steps before implementing

• check the trust records carefully so that the source and character of the proposed distributions are understood before any payment is made;
• review the school contract and identify who is legally liable for the fees;
• if a parent is to sign, consider a written agency arrangement with the trustees in place before the fees arise;
• keep trustee minutes and payment records so the legal and tax analysis is evidenced from the start; and
• remember that a parent-funded trust or bond raises a different set of issues, including the parental settlements code and related attribution rules for minor children.

Takeaway

Using trust income to fund family expenditure can be much more efficient than paying everything from a high-earning parent’s taxed salary. But, where school fees are involved, the legal payment mechanics should be checked before relying on the result. In practice, a direct trustee-school contract or a clear agency arrangement may be just as important as the arithmetic.

This article is provided for general information only. It does not constitute tax, legal or other professional advice, and should not be relied on as a substitute for specific advice based on your particular circumstances.