Lee Sharpe looks at distributing business income around the family – with pointers on how to do it and how not to do it.
A quite recent tax case involved profits being distributed amongst family members, and it did not go at all well for the taxpayer. This article looks at the principles and why the taxpayer in that case came unstuck.
Principles
It is largely acceptable for a business to pay a spouse, sibling, child, etc. for work that they do. To be tax-deductible, however, the cost must have been incurred ‘wholly and exclusively’ for the purposes of the business. Basically, the relative must have done valuable work or provided a valuable service to warrant payment at that scale.
So, one cannot pay one’s son or daughter £3,000 a month for an hour’s paper filing every week, and expect to reduce the business’s annual taxable profits by £36,000. But if the daughter were (say) studying e-commerce at university and demonstrably spending seven hours a week providing valuable expertise to maintain the mother’s thriving commercial website (where the mother might otherwise have to spend £150+ an hour for such expertise on the open market) then actually £3,000 a month becomes a justifiable bargain.
Also, it is generally accepted that a fair proportion of high expenditure may be allowed (e.g., £50 a week for a couple of hours’ administrative work) as being that part that is ‘wholly and exclusively’ incurred for business purposes.
So, one might conclude: “I’ll put through £500 a month for my son’s wages, and the worst that can happen is that HMRC will beat me down to a more reasonable amount”. For example, in Copeman v Flood (William) and Sons Ltd [1941] 1 KB 202, the case was referred back to the Commissioners, to determine what proportion of the business’s claim might be deemed to satisfy the ‘wholly and exclusively’ requirement.
Unfortunately, this is not what happened to the taxpayer in the more recent case Cation v HMRC [2021] UKFTT 311 (TC).
In a nutshell…
In Cation, the taxpayer was a successful chartered surveyor, having operated in employment for many years. Alongside his employment, he set up his own self-employed business that specialised in bespoke glazing systems for architectural purposes, and in 2014/15, he invoiced £70,000 as sales but claimed (amongst other things) an amount of £30,000 as the cost of hiring his father for “sales and marketing support, as agreed”.
Following an enquiry, HMRC disallowed any tax relief for the £30,000. The taxpayer disagreed, and the case was then heard at tribunal.
Wholly and exclusively?
The judge spent a good proportion of the case notes trying to pin down what the taxpayer’s father positively and substantively did for his son’s self-employed business to warrant the payment made. In the absence of a formal agreement, the judge found that father and son simply agreed that £30,000 represented fair value for the work undertaken over an almost-four-year period.
I think it would be fair to say that the taxpayer’s father did not help his son’s case overmuch – one line, in particular, caught my eye, where the father said [he] “did not feel it was a piece of consultancy work” but “covering some of his [son’s] time”; “helping him out, not seeking payment; not the way [he understood] it”.
While there was much more throughout the case notes than this, it would seem quite a stretch to allow the cost of paying someone who did not actually seem to expect to be paid (to be clear, although it is possible in some cases to claim relief for ex gratia payments, it is certainly not straightforward to demonstrate that paying someone who thought they were working for free was actually incurred wholly and exclusively for the purposes of the business, so should be tax-allowable).
Timing and evidence
The judge complained of a lack of historic or contemporaneous evidence of the work done by the father to justify the cost:
“Where was the real purpose of the £30,000 expense to be found? In terms of documentary evidence, there is a dearth of contemporaneous records to support the appellant’s case. What was so obviously missing is a collateral written agreement to substantiate the terms between the payer and payee for the £30,000 fees.”
The taxpayer also took a long time to pay his father for the work done, with two corresponding payments of £10,000 made in early 2017, roughly two years after the tax year under enquiry. This did not sit well with HMRC: “It is unclear to HMRC what happened in the 15 days after the opening of the enquiry that prompted the appellant to pay ‘a large chunk of the payment [he] had claimed as an expense two years earlier.’”
It could be argued that HMRC was wrong to assume that the enquiry and payments were linked, but more importantly, the tribunal judge likewise decided that the two lump sum payments of £10,000 each to the father, on 25 January 2017 and 10 February 2017, were “most probably” triggered by the opening of the enquiry on 10 January 2017.
Something out of nothing?
One might discern a ‘less-than-positive’ outcome for the taxpayer. An important – but fundamentally flawed – argument that the taxpayer made before the tribunal was that, put simply, if HMRC were to contend that the payment was not wholly and exclusively for business purposes, then HMRC had to identify what the payment really was for. The judge said that this approach was quite wrong: if HMRC denies relief and closes an enquiry under self-assessment, on appeal it is for the taxpayer to explain why an amount should be deductible, rather than for HMRC to prove why it should be disallowed.
The fact that the judge disallowed all the amount claimed rather than granting a proportion of the cost is notably unusual. The judge did consider the possibility of apportionment but found that the taxpayer had provided no basis for apportionment. Again, the taxpayer did not help himself by effectively taking an ‘all-or-nothing’ approach to the availability of relief (while there was some discussion of apportionment in the hearing, it seems to have been too little, too late, to give the judge something she was comfortable to work with).
So, there are lessons to be learned in terms of procedure, but also that (as almost always) contemporaneous evidence carries significant weight in cases like this. Payment was rendered some time after one might expect, and there was little to show for the quite valuable arrangement between father and son at the time.
Where larger sums of money are involved, I might recommend the following key elements in the hope of mounting a successful claim:
- contemporaneous documentation (on paper, or by email) that sets out what the relative is doing in exchange for payment, including invoices; and
-
payment at or around the time of the work itself, not several years after the fact.
Ironically, the tribunal noted that one of the father’s contributions was to strongly advise his son against going into partnership with people “you don’t really know”. It is perhaps unfortunate that he did not recommend that his son instead went into partnership with someone that he did really know (i.e., his father) on the basis that profit-sharing between partners, in a genuine partnership at least, is less susceptible to the payment-for-value argument that HMRC deployed so effectively in this case. See, for example, HMRC’s Partnership manual at PM137000: “the profit-sharing ratio need not be in proportion to contributions of [either] effort or capital”(but note that partnerships are not a one-size-fits-all solution).
