Jennifer Adams considers whether employing family members can be a useful strategy to reduce the tax liability for an owner-managed business.
With an owner-managed company, a family member could be a shareholder as well as an employee, and payments from the company can be a mixture of salary, bonus, benefits (including the £300 employee 'trivial ’gifts' allowance) and dividends, thereby not only reducing the company’s tax bill but enabling withdrawals at potentially a lower personal tax rate than if a sole director-shareholder runs the company.
Other non-tax reasons for employing a family member include enabling that employee to be given National Insurance contributions (NICs) credit towards their state pension entitlement. In addition, an employee's salary counts as relevant earnings for private pension contributions purposes – making the family member a director (even with just the secondary NICs threshold salary of £758) and tax relief for payments made through the company up to the annual limit of £60,000 are possible. Employing a family member can ensure that the administration or core business services are being dealt with, thereby freeing up the main earner to maximise company income and grow the business.
However, care needs to be taken for the payments not to fall foul of the 'settlement’ rules. The relationship must be a commercial one, with proof that work has been done at a fair price.
'Settlements' rules
The settlements legislation is an anti-avoidance provision available to HMRC to counter income being diverted from directors to family members who pay tax at a lower marginal rate than the director (often termed 'income splitting'). The question here is whether, by allowing the family member income from the business, they are actually earning a PAYE salary or whether the owner-director has created a settlement and retained an interest in the business.
Should a settlement be created, that income is treated as still belonging to the settlor (in this instance, the director).
Note: The last tax case brought by HMRC under this heading was over ten years ago, so the settlement rules are possibly low on their list of priorities.
How much to pay?
HMRC will want to establish that the family member actually works and is not being paid just to take money out of the business. HMRC will then assess whether the work justifies the amount being paid. If no or little work is undertaken, HMRC could refuse the company a tax deduction and treat the payment as a distribution to the director. However, a small salary could be considered by appointing the family member as a director, even if little actual work is undertaken.
Otherwise, the market rate is used, although this could be adjusted if the family member works weekends and evenings, which an ordinary employee may not be inclined to do without being paid additional for overtime.
How to pay
HMRC is not averse to business owners employing family members; it is more interested in any benefit derived by the business. Payments must be made 'wholly and exclusively' for the trade and not simply because the individual is a family member. Most importantly, a tax tribunal case in 2018 confirmed that any payment must be paid into the family member’s personal bank account and recorded in the accounts as payment as with any other employee; the company should also comply with the Real Time Information requirements of a payroll scheme.
The tribunal case confirmed that even if there had been one payment per month from the business's bank account and a matching invoice from the son, this could have gone a long way to support the appeal, but there were no such records to reconcile with the business's bank statements. A written agreement between the two would have helped, as would a formal job description.
Practical tip
HMRC is more likely to query situations where a family member's name suddenly appears on the payroll showing payment above the going rate for the work undertaken. Where that person is the only employee or has a unique role in the business, determining the right pay level may be difficult.
