Using The Family Company To Support A Student Through University

Sarah Bradford explores opportunities for using the family company to support a student through university.

Being a student can be expensive for mum and dad, as well as for the student. Most students need to find a way to supplement their maintenance loan, as this is often not sufficient even to cover their accommodation costs. Often the student will take on a part-time job, but many seek help from the bank of mum and dad! Where there is a family company in the mix, this offers a vehicle for supporting the student through university.

One option which may be attractive to parents (if less so to the student!) is to employ the student in the family business. While this may be seen as beneficial to develop the student’s work ethic by requiring him to work for the money, it can also be tax-efficient for the company.

From a tax perspective, family companies want to extract profits in a way that is tax-efficient. One way to do this is to pay the student a salary.

For most students, retirement and state pension eligibility are a long way off, and who knows whether there will be such a thing as a state pension when today’s students come to retire. Consequently, ensuring that the year is a qualifying year for pension purposes is unlikely to be a priority. However, building up a contributions-record also earns entitlement to contributory benefits, and as such is always worthwhile.

Understandably, the student will be keen to keep as much money in his pocket as possible. So, perhaps the first question to answer is how much can be paid to the student before any tax and National Insurance contributions (NICs) are due.

Assuming that the student has no other income, no tax will be payable until his or her personal allowance has been used up. This is set at £11,500 for 2017/18. However, NICs kick in earlier, and primary contributions are payable by the student once his or her earnings exceed the primary threshold, set at £157 per week (£680 per month; £8,164 per year). Consequently, if the student is paid a salary of £680 per month, no tax or NICs will be payable and the student gets to keep the full £680 per month. 

A further benefit is that a salary of this level is more than sufficient to ensure that the year is a qualifying year for pension and benefit purposes. Where earnings are between the lower earnings threshold (£113 per week, £490 per month, £5,876 per year for 2017/18) and the primary threshold, the employee is deemed to have paid NICs at a notional zero rate. Therefore, if the parents do not wish to pay the student as much as £680 per month, they may wish to pay at least £490 to ensure that the year counts for contributory benefit purposes. 

From the company’s perspective, salary paid to the student is generally deductible in computing profits for corporation tax purposes. For the financial year 2017, the corporation tax rate is 19%. This means that the effective cost to the company of paying the student a salary of £680 per month is only £550.80 (the CT saving on a salary of £680 per month is £129.20 (£680 @ 19%)). 

Given that there are advantages all round to paying a salary, could it be beneficial to pay one at a level that is above £680 per month (the maximum that can be paid NIC-free)? The answer to this will generally be `yes’.

The salary will be tax-free until the personal allowance (£11,500 a year) is used up. This means it is possible to pay a salary of around £958 per month tax-free. However, once the salary exceeds the primary threshold, employee NICs are payable. This means that if the student is paid £958 per month, he or she will lose £33.36 in NICs (i.e. 12% (£958 - £680)), leaving him or her with net pay of £924.64.

Where the employee is under the age of 21, as will be the case for many students, no employer NICs are payable until earnings top the upper secondary threshold for under 21s. This is set at £3,750 a month (£866 per week, £45,000 per year) for 2017/18. A salary of £958 per month is comfortably within that. Even if the student is aged 21 or over, the employment allowance may be available to shelter any employer NICs that would otherwise arise. 

The lack of employer NICs makes paying a salary of up to the personal allowance worthwhile. As noted above, salary is deductible in computing profits for corporation tax purposes and the employee’s NICs of £33.36 per month will be more than offset by the corporation tax saving of £52.82 a month (i.e. 19% (£958 - £680)). 

The student must actually do work commensurate with the salary being paid to keep the taxman happy.

If the student is a shareholder in the family company, it may be possible for them to extract funds from the company by way of dividends. Of course, a transfer of shares to the student, or a subscription for shares by the student, can have tax implications. These aspects are beyond the scope of this article, which focuses instead on the tax treatment of dividends in the student’s hands. 

Dividends are paid out of retained profits, and unlike the money used to pay a salary, the money used to pay a dividend has already suffered corporation tax. Thus, £100 of pre-tax company profits will only be sufficient to pay a dividend of £81. That is not to say that dividends should be ignored when looking to help support a child through university.

Under the tax regime applying to dividends, all taxpayers, regardless of their marginal rate of tax, are entitled to a dividend allowance of £5,000. This is essentially a 0% tax band, as dividends covered by the allowance are taxed at a zero rate. When formulating dividend policy, it therefore makes sense to pay the student £5,000 of dividends to utilise this allowance (once the parents and other shareholders have utilised their allowance).

However, this is not as straightforward as simply paying the student a dividend of £5,000. 

With dividends, unlike salary, the company does not have the flexibility to pay what it likes. Firstly, it can only pay a dividend if it has sufficient retained profits. By contrast, a salary can be paid even if this results in the company making a loss. Secondly, dividends must be paid in proportion to shareholdings. In a family company situation, this may not be desirable.

There is, however, a possible solution, and this is to have an alphabet share structure whereby each family member has a different class of share – ‘A’ ordinary shares, ‘B’ ordinary shares, etc. The beauty of this structure is that different dividends can be declared for each class of share, or dividends can be paid for some classes of share but not others. This allows the company to tailor the dividend payments to the recipient. Where such a structure does not exist, it is possible to change this by following the correct procedure (normally a special resolution and filing form SH01 at Companies House).

Once the dividend allowance has been used up, dividends are taxed at 7.5% to the extent that they fall within the remaining basic rate band, at 32.5% where they are in the higher rate band, and at 38.1% where they are in the additional rate band. From a profit extraction perspective, it may be beneficial to pay dividends to the student to use up his or her basic rate band, before paying dividends to another family member where these would be taxed at the higher dividend rate. However, the student may need to contribute to household expenses when home for the holidays!

A family company can be a useful vehicle for supporting a student through university. Depending on the level of financial help that the family wishes to provide, consideration should be given to paying a salary of up to £11,500 and making any further payments as dividends.