Chris Thorpe looks at issues of involving members of the family in the business and the potential minefields.
In February 2012’s edition of Tax Insider, Sarah Laing wrote an article about employing family members i.e. putting their wages through the books and claiming the tax deduction. The upshot of the article was that provided they are working as genuine employees, such that the expense is wholly and exclusively for business purposes, then it is perfectly acceptable. Indeed, within a family-run business there is often little option, but it allows more tax-deductible money to stay within the family.
Sarah did touch upon one tax planning idea for limited companies which takes the notion a little further – instead of (or in addition to) paying family members a salary, give them some shares and allow them to take dividends. Everyone has a £2,000 dividend allowance, they attract no NICs and dividends attract a lower income tax rate. Many family companies do just this by creating alphabet shares to allow the flexible payment of dividends. This can be in addition to any salaries so can be done alongside any existing salary planning.
The same thing could also be done with partnerships with family members being given a profit share. Whilst this doesn’t have the intrinsic income tax/NIC benefits of dividends, it would spread the income across more members of the family, thus making full use of multiple personal allowances and basic rate bands.
However, bringing family members in with shareholdings or partnership shares should be accompanied by a degree of caution. The settlements legislation (sections 624-627 ITTOIA 2005) has been in existence for near a century and is designed to stop people precisely doing that – diverting income to another person who pays income tax at a lower rate. Several celebrities over the decades have been caught by this legislation e.g. Jack Hawkins in 1961 (Crossland v. Hawkins [1961] 39 TC 493, Court of Appeal) and Hayley Mills (Mills v. CIR [1974] STC 130, House of Lords) were both deemed to be taxable on the income which was generated by their appearance in numerous films. Whilst the income had been diverted to limited companies and trusts, in both instances the Courts held that in reality the income was theirs, from the fruits of their labours, and as such should be taxed upon them.
Another relatively recent case was ‘Arctic Systems’ (or Jones v. Garnett [2007] UKHL 35, to give it its proper name). This concerned two spouses rather than parent and child. A husband and wife were both receiving dividends as 50:50 shareholders in their company. The issue for IR/HMRC, was the fact that the husband only took a salary of £6,520 – way below a commercial salary for an IT consultant like him. As a result of this, the distributable reserves within the company were artificially inflated with half subsequently being distributed to his wife (£25,767 each). Those dividends going to his wife were actually the husband’s rightful remuneration for the work he was doing, and for which he forewent a normal salary. The House of Lords held that this did indeed fall foul of the settlements legislation; however, what got them off the hook was the spousal exemption which allows gifts between spouses of anything which isn’t purely income – in this case the wife had her shares. Prior to 1990, this would never have been an issue as ‘aggregation’ meant a husband was taxed on his wife’s income anyway. In more enlightened times, however, the legislation applies to spouses as well as children and other family members.
A little bit like salaries, provided the recipient of the dividends/profit share is doing something to justify them rather than relying on the industry on others, the settlements legislation should be no impediment to effectively remuneration planning.
