Keeping it in the family
Employing family members
According to statistics, more than 60 per cent of UK businesses are family owned.
Employing family members means that it should be possible to take advantage of lower tax rates and personal allowances that may be available to spouses, civil partners, and/or children. In turn, this arrangement can help reduce the household’s overall tax bill. A few rules, however, do need to be kept in mind when taking on family members:
– The relative has to be hired to do real work at a proper commercial rate. HMRC are likely to query payments of £50 per hour to a 10 year old who is ’employed’ to take telephone messages.
– Local authorities have rules on children working. The rules do not usually apply to a few hour working at home, say, stuffing envelops. However, if you want to employ a child under 16 in other circumstances, you will need to check with the council first.
– Family members (over 16 years of age) who earn more than the National Insurance contributions (NIC) primary threshold of £146 (for 2012/13) in any week are liable for NICs. In addition, the employer will also have to pay NICs on their behalf.
– The money does actually have to be paid to the employee. HMRC may ask to see evidence that the money has gone from the business to the family member concerned. It is important, therefore, to keep proper records of all payments made.
Clint runs a small window-cleaning business. His 16 year old son helps him out for five hours a week at £7.00 per hour, earning a total of £35 per week. This amount equates to £1,750 a year, allowing for school holidays and some overtime. Clint can offset the £1,750 he pays his son against his profits for income tax purposes. Provided his son has no other income, he doesn’t have to pay any tax on the money because he falls well below the annual tax-free personal allowance (£8,105 in 2012/13). If Clint had done the work himself and not employed his son, that £1,750 would remain part of his taxable profits for the year and he would be liable to pay tax on it. If he was liable to income tax at the higher rate of income tax of 40%, the household would have received only £1,050 (£1,750 less 40 per cent) instead of the full £1,750.
As stated above, excessive remuneration is not deductible for income tax purposes. This was illustrated, for example, in Copeman v William Flood & Sons Ltd (1940) 24 TC 53 (see also Dollar v Lyon (1981) 54 TC 459). In an employment tax case (where remuneration paid to other employees is rarely allowable), HMRC accepted that a secretarial salary paid to the employee’s wife was incurred both ‘necessarily’ and ‘in the performance of the duties’, but HMRC were partially successful in reducing the quantum of the claim (Evans  TC 00446).
Subject to that qualification, remuneration paid to members of the employer’s family is allowable in the same way as payments to other employees. It has to be shown, however, that the money claimed to have been paid, was in fact paid to, and received by, the employee. (Abbott v IR Commrs (1995) Sp C 58).
Employing a spouse or partner can be particularly tax-efficient where trading is undertaken through a limited company. If a spouse or civil partner is a shareholder in the company, and is also employed in it, they can be paid a mixture of salary/bonuses, benefits, and dividends, thereby reducing everyone’s overall tax bill quite considerably.
If Stanley wants to (and has the means to) take £50,000 a year from his limited company, regardless of whether the amount is paid as salary or dividends, a 40 per cent tax bill will apply to the top slice of his income. Contrast this with George and Brenda who own 1 per cent and 99 per cent respectively of the shares in a business. They do not have income from other sources. They wish to (and have the means to) take £50,000 a year from the business. If George receives say, £30,000 in salary, he will only pay income tax at the basic rate along with NICs. The remaining £20,000 can be paid out as dividends. Brenda receives £19,800 (in relation to her 99% shareholding), whilst George receives only £200. Brenda’s income is well within the basic rate threshold so she doesn’t have to pay any additional tax on the dividend received. George’s share of the dividend won’t push him into the 40% bracket either.
An alternative would be to pay Brenda £20,000 in salary. She would have to pay total tax and NICs of £4,038 (in 2011/12). Although this method leads to more tax being paid than going the dividend route, it still works out a good few thousand pounds less than paying the £50,000 salary straight to George.
Protecting benefit rights
Where a spouse or civil partner is employed in the family business, it is possible to pay him or her between £102 and £136 per week (2011/12 rates; rising to £107 and £146 per week respectively in 2012/13), and although there will be no liability to NICs, the employee’s entitlement to a future state pension and other state benefits will be protected.
Cars provided for family members
Where two or more members of the same family work for the same employer and each is provided with a company car, the general principle is that each is only taxable in respect of the car made available to him (Income Tax (Earnings and Pensions) Act 2003, s. 169). A particular issue arises, however, if one of the individuals is in lower-paid employment and is therefore potentially exempt from any tax charge on the company car. Suppose, for example, a wife works for her husband’s company (she is not a director) on a part time basis. Both spouses have company cars. Assume that the wife is not taxable on the car as her overall income is below the £8,500 limit (including the value of the car itself and any associated costs). In this case, the husband will be taxed on the benefit of both cars unless the wife has the benefit of the car in her own right (referred to by HMRC as the primary condition) and one of two further (secondary) conditions is also met.
Not surprisingly, HMRC take a hard line on how to interpret these conditions. HMRC will focus initially on the primary condition, which must always be met if the exemption is to be available. The issue here is whether the secondary employee has the benefit of the car in his or her own right, and not by virtue of the relationship with the primary employee. This will be largely a question of fact. If this condition is not met then the husband will have to pay tax on the benefit of the car. If, in the above example, the car is also made directly available to the husband then he will again have to pay tax on the benefit in kind. The car will technically be a shared car, but the wife’s use of it will be ignored if she is an excluded employee, so he will pay tax on the full amount of the cash equivalent.
In addition to the primary condition, one or other of the secondary conditions must be met:
- Condition A: equivalent cars must be made available on the same terms to employees who are in similar employment with the same employer (and who are not members of the family or household of employees paying tax on benefits in kind); or
- Condition B: the fact that an equivalent car is made available to the second employee must be in accordance with the normal commercial practice for an employment of the kind he or she has. HMRC paraphrase the first of these two conditions by saying that ‘the section requires a comparison with arrangements at arm’s length where there is no personal relationship to affect matters’. The HMRC view (EIM 23565) is that the concept of ‘equivalent’ means ‘equivalent in terms of size, status, age, list price (but not necessarily the same model)’. If an equivalent car is not made available then the first secondary condition is not met
(even if it is argued hypothetically that it would be made available if there was an equivalent employee). In considering whether two vehicles are made available on the same terms, HMRC will want to know (per EIM 23565) whether the cars are taxed, insured and serviced on the same basis, and will also look at the presence or absence of private use payments or capital contributions. To ascertain whether two employees are in similar employment with the same employer, HMRC will look at the role undertaken by the spouse, hours of work and level of remuneration.
HMRC assert that any claim that the provision of the vehicle is in accordance with normal commercial practice ‘will need supporting evidence (a mere belief or assertion is insufficient). In the absence of such evidence, condition B is not met’ (EIM 23570). The legislation insists that the comparison must be over the provision of an equivalent car. Once more, HMRC take a hard line on this: ‘This means equivalent in terms of size, status, age, list price (but not necessarily the same model). The fact that a car that is not equivalent is made available is irrelevant: if the taxpayer cannot establish that an equivalent car is made available, condition B is not met.’ In determining normal commercial practice, HMRC do not accept the argument that the employee’s overall remuneration package is commercial: ‘This condition is not directed at ascertaining whether or not the overall remuneration package was set at a commercial level or whether it was in some way commercially convenient for the employer to ensure that the employee in question was provided with a company car.’ ‘Instead, the test quite specifically tells us to focus on the making available of the car alone. Is it the case that the making available of an equivalent car is in accordance with the normal commercial
practice for an employment of the kind held by [the second employee]?’
Employing family members in a family-run business often means that it is possible to structure things so as to take advantage of lower tax rates and personal allowances, which in turn will reduce the household’s overall tax bill. A careful eye needs to be kept on the specifics of the relevant tax legislation and as always, taxpayers need to look at the wider picture and never do anything for the sole purpose of avoiding tax.
If you have any queries regarding the content of this article please contact Terry at our Taunton office on (01823) 325610.