Joe Brough examines opportunities and pitfalls where a business owner employs family members.
This is just one area of business taxation covered in our newly released tax report 'Tax Planning for Family Companies' .
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It is common for family members to be employed within owner-managed businesses. When employing family members, taxpayers need to be aware that where remuneration is set at an uncommercial rate, HMRC may seek to disallow a portion of the expense when computing their taxable profits.
When considering whether remuneration is set at a commercial rate, it is not only the salary that is considered. Benefits-in-kind and pension contributions that form part of the overall package also need to be taken into account.
Where family members are employed by the business, the business owner must also be aware that there are statutory laws that must be followed. However, where remuneration is set at a commercial rate and employment laws are met, this does lead to tax planning opportunities that businesses can take advantage of.
Wholly and exclusively
For a deduction to be allowable for tax purposes, an expense must be incurred ‘wholly and exclusively’ for the purposes of the trade. If HMRC can successfully demonstrate that this is not the case, a portion of the expense relating to the uncommercial element will be disallowed in computing the profits from the trade. However, where the expense is employment income, the full amount is still subject to tax on the employee.
When considering whether a remuneration package has been incurred wholly and exclusively for the purposes of the trade, there is no hard and fast monetary value as to what HMRC would consider to be acceptable. In such cases, a qualitative approach in determining what is to be considered a reasonable level of remuneration would be taken.
It is therefore feasible that two business owners, who both pay their spouses the same salary, find that one has an element of the expense disallowed, whilst the other is allowed a deduction in full.
For example, where other members of staff are paid at a lower rate for performing the same (or substantially the same) work, this would indicate an element of uncommerciality in favour of the family member. Similarly, if the level of remuneration is not commensurate with the skill or expertise required to perform a particular task, this would also be indicative of an uncommercial arrangement.
Controlling directors
When considering the remuneration package of a controlling director of a company, HMRC does accept, under certain circumstances, that the whole package is the result of a commercial decision and will not seek to disallow a portion of the expense.
Such circumstances will generally arise when the director is the ‘driving force’ behind the company whose work generates the income of the company.
Tax-saving opportunities
Where a business can satisfy HMRC that a deduction for the remuneration package of a family member is allowable, this opens the door to tax-saving opportunities.
Just as it is important to ensure that remuneration is not set too high, it is also important not to ignore the roles family members perform for the business and how this can result in tax savings for the family.
Child benefit retention
Where an individual has adjusted net income over £50,000 for child benefits claimants or their partner, this results in a clawback of the benefit. Where adjusted net income exceeds £60,000, the whole benefit is repayable. Where family members are employed within the business, it is important that their remuneration is correctly claimed, as this could lead to a retention of the benefit.
Example: Employing family members
A sole trader is anticipating taxable profits of £60,000 for the tax year to 31 March 2024. Their total tax and National Insurance contributions (NICs) liability is £15,199. In addition, their spouse claims child benefit for one of their two children totalling £1,248, which will need to be paid back via the trader’s self-assessment tax return.
Following discussions with their tax adviser, it is established that the trader’s spouse, who has no other income, performs administrative tasks for the business. On weekends, the trader’s son also works within the business for no remuneration to repay his parents for driving lessons. He also has no other income. It is determined that their total allowable remuneration is £6,000 each.
If these costs were applied to the trader’s projected profits, this would reduce their taxable profits to £48,000, resulting in a total tax liability of £10,454.10. As their spouse and son have no other income, their salaries will be received without deduction of tax or NICs. In addition, as the trader’s income is now below £50,000, there will be no clawback of the child benefit. The trader would also be able to benefit from the transferrable marriage allowance, saving a further £252.
By formalising the working arrangements, the trader has achieved a total tax saving of £6,244.90. Their son also has their own money to pay for his driving lessons, which are not now being funded from after-tax income.
Trivial benefits
When a family member is employed within the business, the employee or a member of their family or household is able to receive tax-free trivial benefits. The conditions to be satisfied to qualify for the exemption are:
- The benefit is not cash or a cash voucher.
- The cost of the benefit does not exceed £50.
- The employee is not entitled to the benefit as part of any contractual obligation.
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The benefit is not provided in recognition of particular services performed by the employee as part of their employment duties.
Where an employer is a close company, whilst a director and the members of their family and household can still benefit from receiving trivial benefits, the total cost is capped at a maximum of £300 in a tax year.
Employment allowance
The employment allowance is not available for a company where the only person paid above the NICs secondary threshold is a director of the company. Where there is a second employee also earning over the secondary threshold, the full £5,000 employment allowance is available. The second employee can be a family member of the director.
Where the employment allowance is available to cover the employer's NICs on a director’s salary of £12,570 per year, the company will achieve a pre-corporation tax saving of £478.86.
The long arm of the law!
Businesses should remember that the same laws apply to employing relatives as to other members of staff.
Any payments of salary must be reported to HMRC via an RTI (real time information) submission, with PAYE deductions made and paid over to HMRC each month. Similarly, employers must also consider their responsibilities under pensions auto-enrolment legislation, with employees being enrolled into a workplace pension if the qualifying criteria are met.
Businesses must also make sure that payments are made in accordance with the minimum wage legislation. However, where someone is employed by the company as either a director or company secretary, there is some flexibility here as officers of the company are not subject to minimum wage regulations unless they have a valid employment contract, the specifics of which are outside the scope of this article.
In the same way that all deductions from salary must be correctly calculated, reported and paid to the relevant authorities, payment of the net salary must be made to the employee. It is not sufficient to leave the amount outstanding on a loan account or credited to a proprietor’s capital account. HMRC will require evidence of the payment actually being made.
Practical tip
Employing family members can allow for tax planning, which can reduce the tax burden on the whole family unit. To successfully implement this planning, it is important to ensure that the arrangements entered into are commercial and comply with all of the relevant laws and legislation.
