Employing close family - tax efficient or tax trap?
It's common practice for clients to put family on the payroll. This can be tax efficient despite HMRC viewing such arrangements suspiciously. How can you support your clients in their claim for a tax deduction?
Tax deductible or not?
A particular area of contention between businesses and HMRC is whether an expense has been incurred "wholly and exclusively for the purpose of the trade". If it hasn't, no tax deduction is allowed. With this rule in mind, a tax inspector's interest will be especially piqued by the appearance of a payment in a client's payroll or accounting records to a spouse, or other family member, and questions will often follow.
HMRC will first want to establish that the family member actually works and is not being paid just to get money out of the business. It will then assess whether the work they do justifies the salary. On this point, HMRC's internal guidance manual says: "So where there is equal pay for equal value the amount paid is fully allowable, notwithstanding any connection between payer and recipient"
Tip - Keeping good records will go a long way in persuading HMRC that salary paid to your client's spouse etc. is legitimate. For example, advise your clients to:
• Keep the same personnel records as they do for any other employee, including a contract of employment.
• Include the spouse etc. on their payroll and actually pay them, i.e. the salary should not be just a bookkeeping entry.
• When their spouse etc. first starts working for you follow HMRC's protocol for "starters".
• Follow the workplace pension auto-enrolment procedure.
Getting what you pay for
Clients should aim to pay the family member the going rate for the work they do and no more. If they are their only employee or have a unique role in the business, determining what the right level of pay is can be tricky.
Tip - Using your experience and knowledge of other clients' businesses you're in an ideal position to suggest a suitable rate of pay.
Trap - If, despite your efforts, your client has to concede a reduction in the amount of expense qualifying for relief, remember that any corresponding PAYE tax and NI that has been paid is not refundable, i.e. tax and NI still apply even though the client can't get a tax deduction for the corresponding wages.
Job creation scheme
It's important to understand that HMRC has no grounds to disallow a deduction just because a tax inspector thinks the job performed by the family member isn't necessary. For example, just because a client has created a job for, say, his son during his summer break from university to valet the directors' cars or to reorganise the stationary cupboard and other areas of the office, doesn't make it invalid, even if it isn't commercially sensible. Provided the salary that your client pays the family member is at the going rate for the work done and that the work is wholly and exclusively for the business, HMRC can't legitimately refuse a tax deduction.