Chris Thorpe looks at potential issues from employing a family member within a business.
One of my previous Tax Insider articles (March 2021) considered the matter of employing family members, but with specific regard to the settlements legislation (i.e., anti-avoidance provisions addressing the artificial transfer of income to other family members).
Excess profit shares and dividends are historically triggers for HMRC enquiries under that legislation; but aside from the settlements legislation, more fundamentally, what are the issues with employing a family member or giving them shares to receive future dividends?
Excess salary
When employing minor children, there are legal niceties that need to be observed. Amongst a raft of other rules, children cannot work in factories; go up chimneys; be sold to the Royal Navy; work during school hours, or before 7am or after 7pm.
The legalities aside, HMRC treats children (and adult family members or dependents) like any other employee provided their salary, benefits and pension contributions are paid wholly and exclusively for the purposes of the business, i.e., it must be a genuine market salary for work that is actually done. Only if the payment is thus can the business claim a corresponding tax deduction; any ‘excessive’ remuneration will be disallowed as this would be deemed a ‘personal’ payment.
In Nicholson v HMRC [2018] UKFTT 14 (TC), a self-employed individual paid his son (who was at university) a £7,400 ‘salary’ for his employment in leafleting and advertising and IT work; however, there was no PAYE scheme, no records of work done and some of the £7,400 consisted of directly paying some of his son’s food bills and other university expenses.
The First-tier Tribunal held that the £7,400 was not exclusively salary. Instead, it was a father helping out his son financially out of natural love and affection; this duality of purpose meant that father could not deduct these payments as a business expense. If his son had had a proper employment contract, with documented hours worked with a corresponding salary, and thus had been treated like any other employee, there would have been no issue.
Could a parent give a child some shares instead and allow them to have dividends?
Gifting shares: in what capacity?
The main issue with dividends is the settlements legislation, particularly concerning spouses and minor unmarried children. There are obviously no business tax deductions for dividends (or partnership shares), so it is not the same issue as with salary.
However, what about gifting the shares in the first place? If a family member is an employee or officeholder and they receive company shares (whether that be newly-issued shares or the gifting of pre-existing ones), an income tax charge may arise under the employment-related securities (ERS) rules. The tax charge would be applied on the difference between the value of the shares and the amount paid for them (if any).
In a family business, where shares are passed from parents to children as part of business succession, ERS is rarely an issue as there is a specific exemption for ‘transfers of shares in the normal course of domestic, family or personal relationships’. As long as the motivation behind the transfer was unconnected to the child’s employment in the business, there would be no tax charge. If, however, the children received shares alongside other employees, the motivation behind the gift might be questioned.
Practical tip
There is no reason whatsoever why a family member cannot be employed within someone’s business, as long as they are treated the same as any other employee (i.e., paid a market wage for work carried out). If that is the case, HMRC has no grounds to tax the salary or relieve the expense any differently. Shares can be gifted to family members who subsequently receive dividends, provided those shares were gifted to recipients purely as family members and not in their capacity as employees.
