For owner-managed business to pay school or university fees through the company can appear attractive, especially if the company has surplus cash. However, tax consequences may arise for the individual.
Should the company reimburse the individual, the amount counts as earnings subject to PAYE income tax as well as employee and employer Class 1 NIC. Therefore, reimbursement is generally the least efficient method of funding.
Company’s tax position
Where a company pays for a course undertaken by an employee or director, the expense is only tax deductible if it is incurred ‘wholly and exclusively’ for business purposes. Direct payments to an educational establishment will generally fail this business purpose requirement and are therefore not tax deductible.
Benefit in kind
The most straightforward method is for the company to contract directly with the school or university. The employee will be charged a benefit in kind (BIK) on the payment made, the company pays tax Class 1A NIC, but no employee NIC arises. As Class 1A NIC is corporation tax deductible, this route is typically marginally more efficient than paying additional salary.
For higher rate taxpayers, the corporation tax deduction rarely offsets the combined income tax and NIC exposure for the employee.
The loan alternative
An employer may lend funds to an employee to cover tuition fees. A formal loan agreement should be drawn up, including interest and repayment terms.
Provided the total outstanding loans do not exceed £10,000 at any point in the tax year, no taxable benefit arises on an interest-free or low-interest beneficial loan. The employee’s only cost is any interest charged under the agreement.
If the loan exceeds £10,000, a taxable benefit arises based on the difference between the interest charged and HMRC’s official rate (currently 3.75%) The rate can change year on year.
Value of this approach
This approach does not eliminate tax but alters the timing of the tax payment. If the loan is later released or written off, the amount is treated as earnings subject to income tax and Class 1 NIC. The NIC is collected through PAYE, however the income tax is reported on the employee’s Form P11D. The employee is then required to file a Self-Assessment tax return.
Dividend planning and the settlements constraint
A child can own shares at any age (although dividends are typically held in a bare trust until the child reaches 18 years), therefore another possible route that avoids employment income is through share ownership. However, the settlements legislation remains the principal obstacle. If a parent provides shares or funds to their child and the income from those investments exceeds £100 per year, the income is taxed as if it were the parent’s. Therefore, to have dividends taxed on the child, funds need to be provided by someone other than a parent (e.g. a grandparent).
Value of this approach
This approach aims to set aside income for future school fees in a tax-efficient manner rather than as a quick method in which to raise funds. Whether it works depends on the source of the invested money.
Salary sacrifice: Restricted relief
Salary sacrifice is no longer an effective way to reduce the cost of school fees. The employee benefits from reduced gross pay (and therefore lower income tax and NIC), but the taxable benefit is based on the higher of the salary foregone or the benefit value; any excess is treated as taxable earnings.
Value of this approach
Any potential saving may come if the employer negotiates a genuine group discount with the education provider (e.g. with a nursery which several employees’ children attend). The planning opportunity is therefore commercial rather than tax-driven.
Practical point for using a business to pay school or university fees
Calculations are required to ascertain the method that results in the lowest overall tax and NIC liability.
