Trusts and school fees

Given the increase in school fees over the last 20-30 years, and more particularly since January 2025 with the application of VAT to such fees, there has never been more incentive to pay those fees in a more tax-efficient manner.

Trusting in trusts

By using a trust, whose beneficiaries are the children attending the school, those children are essentially the taxpayers of the trust income being used to pay the fees; with children also having an
income tax personal allowance and usually a full basic-rate band, the income in their hands (via the school’s bursar) is subject to a lower tax rate than that of their parents.

An income-producing source is placed into trust – usually family private companies – with alphabet shares to ensure that income going to the trustees is tailored to meet the school (and associated) fees.

By having trading company shares, the trustees can usually benefit from business property relief (BPR) for inheritance tax purposes – from April 2026, each trust (or each settlor) has the same
£2.5m BPR allowance for 100% relief as well as nil-rate bands; this will help mitigate tax due every ten years and if shares are distributed to the beneficiaries when they are older.

Which trust?

Usually, a discretionary trust is used so income distributions can be made to the minor beneficiaries (or often the school directly on their behalf) as and when they are necessary. Whilst the trustees’ income is taxed at additional rates, the income distributions come with a refundable 45% tax credit – the children will be taxed on the gross distribution but with the tax credit, the children will usually end up getting back most of that tax, which can also help with school costs (trips, clubs, etc.).

The tax on the income is shouldered by the child, who also receives the excess tax paid by the trustees; however, the trustees have to pay this additional rate tax, so there can be a strain on the
cash flow.

An alternative is to use an interest-in-possession (IIP) trust, whereby the income arising within the trust belongs to the beneficiary, with no discretion from the trustees (their discretion is confined to the capital). IIP trustees pay income tax at the basic rate on the beneficiaries’ behalf, who then only pay higher or additional-rate tax depending on their marginal rate. That income from the trust can still be used to pay school fees in the same way as with discretionary trusts.

What is the issue?

The beneficiaries (as school children) are under 18, so if the income arises from a gift by their parents, those parents are taxable on the income. The ‘settlements’ legislation applies when a gift
(or any form of ‘settlement’) is made and the person who makes it (the ‘settlor’) or their spouse or minor unmarried child can benefit from the settlement – such as a parent putting shares into trust for the benefit of their own children; if this is the case, the settlor of the trust will be taxable.

The easiest way around this is for someone other than the children’s parents to place the shares into trust – the grandparents being the most common example.

However, the grandparent must be a genuine settlor, and this is where the risks can present themselves. If the parent can be shown as the true settlor, then HMRC can impose the settlements legislation; the definition of a settlor is very wide and indirect or even reciprocal arrangements can be caught. If the grandparents were given the shares by the parents or able to obtain them in any non-commercial way, then that would likely be caught.

Practical tip

Trusts can be used to pay school fees on behalf of minor children in a tax-efficient way, but the genuine settlor of the trust must be anyone other than their parents.

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