Paying salary to a family member

One of the more tax efficient ways of reducing a company’s tax bill and increase the amount of money withdrawn at the same time, is by paying salary to a member of the director’s family. This could be the director’s spouse or children at university. Partner Joanne Gibson advises in this article.

Another good reason for employing a spouse is that it gives them employee NIC credit towards their state pension entitlement. An employee’s salary will always count as ‘relevant earnings’ to enable private pension contributions.

However, care does need to be taken so that the payments do not fall foul of the ‘settlement’ rules. The central question here being, that by allowing the family member income from the business, are they earning a PAYE salary or whether the owner/director has created a settlement and ‘retained an interest’ in the business?

The ‘settlements legislation’ is available to HMRC to counter income which is being diverted from directors to family members who pay tax at a lower marginal rate than the director. This is called ‘income splitting’.

Should an individual create a ‘settlement’ but retain ‘an interest’, then under this legislation, the income of that settlement is treated as still belonging to the settlor, in this case, the director. ‘Retaining an interest’ includes a situation where the settlor’s family member can benefit. On its own, this would prevent tax savings by making gifts of income-producing assets to family members paying lower tax rates. However, an ‘outright gift’ is not part of these rules provided that the gift carries a right to the whole income and is not ‘wholly or substantially a right to income’.

To qualify as a deduction against the company’s tax on its profits, the family member needs to be really earning the amount that is paid to them. The amount paid must be in return for the work they undertake. If no work or little work is undertaken, then HMRC could refuse the company a tax deduction and treat the payment as a distribution to the director. For example, paying a spouse or civil partner £50,000 a year for one day’s work a week might be challenged by HMRC and, if upheld, would result in the expense being disallowed as not being incurred ‘wholly and exclusively’. The salary must be reasonable for the work undertaken. A salary greater than would be paid to another non-family member to do the work could be investigated by HMRC. However, by appointing the family member as a director, a small salary could be paid, even if the actual work undertaken is relatively little.

IN SUMMARY
Here are our tips and recommendations:

• By paying the ‘optimal’ salary amount of £12,570, this also means that the family member has a year’s NIC contributions towards their state pension without having to pay any employee’s NIC. Although this could also be achieved if a salary equal to the lower earnings limit of £123 per week (£6,396 a year) is taken.
• The salary should be paid into the family member’s personal bank account and recorded in the accounts as payment to another employee; the company will also need to comply with the Real Time Information requirements of a payroll scheme.
• Should the family member also be a shareholder, there will also be the option of withdrawing more from the company if needed.

The team at JRW Hogg & Thorburn would be happy to discuss this and other related matters, please do contact them directly.