Sarah Laing highlights a potentially costly mistake to be avoided when paying family members.
In a family business situation, it is generally desirable to spread income around family members where possible, to maximise the use of annual personal tax allowances, and to potentially take full advantage of nil and lower rate tax thresholds.
The term ‘family’ could include anyone who depends on a particular individual (e.g. the owner of the family company) for their financial well-being. However, care must be taken in this area not to fall foul of the ‘settlements’ legislation and other anti-avoidance measures in force at the time.
Some distributions of income to family members will not be beneficial for tax purposes, and to this effect, the following points should be borne in mind:
- wages paid to family members will be tax deductible only if it can be justified in relation to the duties performed;
- wages may attract a liability to National Insurance contributions if they are above the primary threshold (£166 per week in 2019/20); and
- investment income of children is generally taxed on the parents, where it arises from a gift by them.
Justified payments?
The tax deductibility of wages by a sole trader to his son has recently been considered for tax purposes by the Tax Tribunal (Nicholson v HMRC [2018] TC 06293). The business owner’s (Mr Nicholson) son had been employed in promoting the business through internet and 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.
Mr Nicholson claimed that payments to his son had been paid partly through the ‘provision of goods’. He managed to identify £1,850 in cash by reference to his son’s bank statements. He also substantiated a monthly direct debit of £18.51 in respect of 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 the 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.
Record keeping
The above case highlights the importance of keeping proper records regarding the basis in which payments are to be made to children. The tribunal commented that the likelihood of a successful claim would have been increased had there been payment on a time-recorded basis, or a methodology in calculating the amount payable plus an accurate record of the hours worked. A direct link between the business account and the recipient’s account would clearly be advisable.
The judge noted that had payment been made on a time recorded basis or using some other methodology to calculate the amount payable, and had an accurate record been maintained of the hours worked and the amount paid, it is unlikely that the deduction would have been denied. If Mr Nicholson had made payments to his son’s bank account at the rate of £10 per hour for 15 hours’ work a week, leaving his son to buy food and drink, etc. from the money he had earned working for his dad, the outcome would have been different. Bank statements could have been used to provide evidence of what had been paid and this could be linked to the record of hours worked. Maintaining the link is the key issue here.
Practical Tip:
The importance of paying a commercial rate for the work undertaken is worth noting. The concept of ‘equal pay for equal value’ should help prevent a suggestion of dual purpose and thus, in turn, also help refute allegations of excessive payments to family members as a means of extracting monies from the business.
