Employing Family Members
In recent years with the rise in the personal allowance, currently £11,850 an increase of £5,375, from £6,475 in 2010, it is good tax planning to introduce family members to the business, so that they can be paid a wage. The business receives a tax deduction for the payment and depending on the individual’s circumstances, a tax-free payment if their salary and other income is below the personal allowance. What is not to like!
HMRC have always taken an interest in the employment of family members and the remuneration that they receive. However, with the significant tax advantage following increases in the personal allowance, such arrangements create a higher risk of HMRC challenge.
The key point, as with any business expense, is that the expense, in this case the wages/salary, have to be incurred “wholly, exclusively and necessarily for the purpose of the trade.” HMRC will ask if the payment is actually made of the purpose of the trade, or if there is another motivation, say, university fees.
HMRC may try to assert that the payment is not made in return for services, but as a result of the family relationship and therefore no deduction is available, or that the individual is overpaid and there should be an adjustment. HMRC has a good track record in winning these cases, going back to 1941, in the case of Copeman v William Flood & Sons. This case set the principle that remuneration has to be realistic and not excessive.
Two very recent cases emphasise the key points when employing a family member:
- The importance of paying a commercial rate for the work undertaken.
- The importance of keeping proper records to support work undertaken and payments recorded in the business records.
- Put family on the payroll.
- Actually, pay the money to the family member at the appropriate time and not after the year-end.
The recent case of McAdam v HMRC heard at the end of last year, shows how HMRC will attack the reasonableness of a salary. Mr McAdam, a self-employed plumber paid his spouse £90 per week salary for the admin and accounting functions of the business, including taking telephone enquiries, taking orders and checking part prices. Although £90 per week for the duties described does not sound excessive, when the matter was looked at in detail, the business was in the main run via Mr McAdam’s mobile, which was the advertised number. The wages deduction was successfully reduced by HMRC.
In the case of Nicholson, again late last year, HMRC successfully argued duality of purpose for the payments. Mr Nicholson employed his son for his technical skills promoting the business through the internet, leaflet distribution and computer work. His wages had been calculated at a rate of £10 per hour for 15 hours per week, but unfortunately there was no evidence to support wages being paid on this basis. HMRC rejected the claim because of a lack of contemporaneous records preventing a successful reconciliation from the business bank statements.
Mr Nicholson claimed that payments to his son had been effected partly through the ‘provision of goods’ for his son’s university digs and the payment of ongoing costs for his son, such as his son’s home insurance costs. However, the bulk of the claim was based on Mr Nicholson buying food and drink to help support his son at university.
The tribunal concluded that Mr Nicholson’s payments were made out of ‘natural parental love and affection‘. There was a duality of purpose as the ‘wages’ had a major underlying ‘private and personal’ motive, and thus not for the purposes of the trade. The tribunal subsequently dismissed the appeal on the grounds that Mr Nicholson was doing nothing more than supporting his son at university.
In addition to tax, there are other legal issues that need to be considered:
- National minimum wage – children aged 16 to 17 are entitled to at least £4.20 per hour.
- There are rules for how many hours children under 16 are able to work and the roles they can undertake. The youngest age a child can work part-time is 13, (subject to a few exemptions)
Whilst there is no suggestion that employing relatives is an issue, the importance of paying a commercial rate for the work undertaken should be noted and correct recording, as well as operation of the payment and tax should be adhered to.
Where businesses have consistently uprated a family member’s wages in line with the personal allowance increases, they will need to be able to justify the increases which becomes more difficult if the individuals do not carry out substantive duties.
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Harbour Key May 2017