Tax deductible or not
The main question from 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. A tax inspector’s interest will be especially focused on a payment in your 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 you’re paying. 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 a tax inspector that the salary paid to your spouse or child is legitimate. For example:
- keep the same personnel records as you would for any other employee, including a contract of employment
- include them on your payroll and actually pay them, i.e. the salary should not be just a bookkeeping entry
- when they first start working for you follow HMRC’s protocol for “starters”
- follow the workplace pension auto-enrolment procedure
Getting what you pay for
Aim to pay the family member the going rate for the work they do and no more. If they are your only employee or have a unique role in your business, determining what the right level of pay is can be tricky.
Tip. If in doubt, speak to your accountant as they’re likely to have experience of similar situations and should be able to suggest a suitable rate of pay.
Trap. If, despite your efforts, you have to concede a reduction in the amount you claim as a deductible expense, remember that any corresponding PAYE tax and NI that has been paid is not refundable, i.e. tax and NI still apply even though you 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 your family member does isn’t necessary. For example, you could create a job for your son during his summer break from university to valet the directors’ cars or to reorganise the stationery cupboard and other areas of the office. Provided what you pay him is at the going rate for such work, the tax inspector can’t legitimately refuse a tax deduction.
Tip. Creating a job in your business can be a tax-efficient way to put extra cash in your youngster’s pocket that you might otherwise have to pay out of your taxed income.