Severn Accounting
Tax & Accounting

Beware of diverting dividends to minor children to fund educati

By Ali Jaw ·

Dividend planning can be a clever way to manage your company’s profits and minimise your overall tax bill. However, there’s a tempting trap that many business owners fall into: deliberately routing dividends to minor children to fund their education or living costs. Whilst the intention is understandable, HMRC takes a dim view of this strategy, and the tax consequences can be far more costly than you might expect. At Severn Accounting, we’ve seen this approach backfire for Worcester-based business owners, so let’s explore why it matters and what you should do instead.

The “Settlement” Problem

When you deliberately divert company dividends (or any income-producing assets) to a minor child for a purpose you’ve predetermined—such as funding school fees or university costs—HMRC may view this as a “settlement” under the Income Tax Act 2007. In simple terms, a settlement is when you transfer funds or assets to someone else (especially a minor) in a way that gives you (the transferor) a benefit or maintains your control.

The critical issue is this: if HMRC decides a settlement has occurred, the income generated by that transfer is taxed back to you, not the child. So even though dividends appear in your child’s name on the company’s records, you could end up paying tax on that income yourself. This completely defeats the purpose of the dividend diversion strategy.

The legislation specifically targets situations where a parent retains some interest or benefit in the arrangement—for instance, where dividends paid to a child are used directly for parental objectives like school fees. HMRC argues (and often successfully) that the parent has effectively used a back door to redirect their own income.

What Counts as a “Benefit” to You?

HMRC’s definition of benefit is broad. It includes:

  • Using the child’s dividends to pay for their education (school, university, private tuition)
  • Covering living expenses that you would otherwise pay
  • Funding holidays or significant purchases that reduce your own outgoings
  • Any arrangement where you retain practical control over how the money is spent

Even if you’re acting with good intentions, the tax authorities see this as you indirectly enjoying the benefit of the child’s income. This triggers the settlement rules, and you become liable for income tax at your marginal rate—potentially 40% or 45% depending on your other income—rather than the child’s lower rate or personal allowance.

The Personal Allowance Misconception

Many business owners assume that because their child has a personal allowance of £12,570 for the 2024/25 tax year, they can shelter dividends up to that amount tax-free. Technically, this is true in isolation. However, it only applies if the dividend arrangement is genuine and entirely independent of your own interests.

If HMRC believes you’ve created the dividend to disguise your own tax avoidance, the personal allowance is irrelevant. The entire amount becomes taxable income in your hands instead.

Additionally, if your child has other income (such as earnings from a part-time job), their personal allowance is used up, and dividends received above that threshold are taxed at the dividend allowance threshold and then at 8.75% for basic-rate taxpayers.

A Better Approach

Rather than routing dividends to your child, consider these legitimate alternatives:

Direct payment of fees. Pay school or university fees directly from your company. This is a business expense if you’re employing your child (even part-time), or it can simply be a personal expense from your own net income—no settlement issues.

Genuine employment. If your child works for the company in a real capacity, pay them a salary up to their personal allowance (£12,570 for 2024/25). This is a deductible business expense and entirely legitimate. The child pays no tax, and you receive a corporation tax deduction.

Family loans. Lend money to your child (formally documented) rather than gifting it. There’s no settlement, and you retain clear ownership. If it’s a genuine loan, interest rules become relevant only if you charge below-market rates and have other specific circumstances.

Trust structures. If you genuinely want to provide for your child’s future, proper trust arrangements created by a solicitor with clear, independent terms may offer protection. However, this is complex territory and requires professional advice.

The Bottom Line

The investment in getting this right is far smaller than the cost of HMRC discovering a poorly structured arrangement during a tax investigation. Settlement rules apply retrospectively, meaning penalties and interest could apply to several years of returns.

For tailored advice, contact Severn Accounting—we’re here to help.