VAT on private school fees – using the tax system to make fees more affordable

At the time of writing there are three weeks to go until the general election.

They say a week is a long time in politics, but it currently seems highly unlikely there will be any outcome on 4 July that does not include Sir Keir Starmer as Prime Minister, with the Labour Party in power for the first time in 14 years.

There have been rumours for weeks that VAT would be added to private school fees if Labour came into power, but we now know for certain from the Party Manifesto that this will be so, and the additional revenue will be earmarked to fund an additional 6,500 new teachers in key subjects if they get into power.

School fees themselves have risen a lot of the last few years.

The average cost is currently £15-£20k per year, which means that average will increase overnight to £18-£24k.

That is a lot of extra money to be found to fund schooling over several years.

If VAT is added to school fees can the tax system be utilised to help fund the extra fees?

When paying school fees it is important to consider the tax implications and take advice to get the best tax outcome for your situation.

Here are a few areas that are worth consideration:

Use of trusts

This cannot be used by parents funding their children’s education but works perfectly for grandparents.

The grandparents will settle an asset or assets into a discretionary trust for the benefit of their grandchildren.

It does not matter what assets are used, property, shares or cash all work perfectly well.

That asset is removed from the grandparents’ estate for inheritance tax purposes as long as they survive seven years from the date of transfer.

If the asset has increased in value since it was acquired, like property and shares, there will be a capital gain on the difference between the original cost and market value.

However that gain can be held over so that the trust acquires the asset at its original cost rather than market value and no immediate capital gains tax is due.

As long as the value of the assets being settled and any assets settled in the previous seven years does not exceed £325,000 per person there will be no lifetime inheritance tax to pay.

The asset(s) now belong to the trust and the income arising taxable on the trust at 45%.

However if that income is distributed to the grandchildren by way of paying for their fees it will become taxable at their own top tax rate.

For example:

Here’s an example of the potential tax savings available:

Grandfather and Grandmother are higher rate taxpayers and receives £50,000 per year in rental income from their portfolio of three rental properties.

They pay tax of £20,000 on that income and use the remaining £30,000 to help fund school fees for their three grandchildren.

Instead they put their properties worth £650,000 into a joint trust.

They hold over the capital gains and pay no inheritance tax.

The trust now receives the rental income of £50,000 and pays £22,500 of income tax.

However the net income of £27,500 is used to pay the school fees and so is distributed to the three grandchildren who have no other income.

They each have a tax liability of £819 so will get a refund from the tax office of £6,681 each which can be used to top up the school fee pot.

The original income tax liability of the grandparents of £20,000 has now been reduced to £2,457, a reduction of £17,543 which more than covers the school fees hike due to the VAT addition!

Gifts out of income

Another tax efficient way to fund school fees is for grandparents to pay them out of their income if they have sufficient left over after their own living costs.

Any excess of income over expenses can be transferred on a regular basis and if so will qualify for gift out of income relief.

That means the gifts come straight out of the estate for inheritance tax purposes, there is no seven year waiting time for relief.

Use of investments

It is always worthwhile reviewing your investments regularly to make sure your money is working well for you.

There are certain investment products that work well for school fees planning and can be used by parents or grandparents, such as bonds.

By maximising the return on your investments you can help increase the funds available to pay extra school fees.

Don’t forget that there are fee assistant schemes available such as scholarships, bursaries or charitable trusts that might help make your child’s school fees more affordable.

Getting in touch

We are here to help with all your tax planning needs. If you would like to find out more contact Jan Friend or call us on 01634 731390.

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Blogs related to tax planning

Take a look at our other blogs on the topic of tax planning.

Saving Inheritance Tax Using the Family Home

Using Trusts to Save Inheritance Tax

The content in this blog is correct as at 17th June 2024 See terms and conditions.