Business owners often ask if they can employ their wife, husband or children in the company to reduce tax.
What are the rules if you put your wife, husband or children on the payroll?
The answer is yes: you can certainly employ wife, husband or children to reduce tax. Putting them on the company payroll can be tax efficient as long as HMRC accept it.
The important follow up question is: where do you stand if the taxman challenges your claim for a tax deduction?
How it works
A particular area of contention between businesses and HMRC if they employ their wife, husband or children to reduce tax is whether an expense has been incurred “wholly and exclusively for the purpose of the trade”.
If an expense hasn’t been incurred no tax deduction is allowed.
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 are paying them. HMRC’s guidance says “so where there is equal pay for equal value the amount paid is fully allowable, notwithstanding any connection between payer and recipient”.
Keeping good records will go a long way in persuading a tax inspector that the salary paid to your spouse of child is legitimate. For example:
- Keep the same personnel records as you wold 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
- Follow the workplace pension auto-enrolment procedure
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 difficult.
If in doubt, speak to your accountant as they are likely to have experience of similar situations and should be able to suggest a suitable rate of pay.
If, despite you efforts, you have to concede a reduction in the amount you claim as a deductible expense, remember that any corresponding PAYE tax ad NI that has paid is not refundable i.e. tax and NI still apply even though you can’t get a tax deduction for the corresponding wages.
What HMRC can’t do
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 or daughter during the summer break from university to valet the director’s cars or to reorganise the stationery cupboard and other areas of the office.
Provided what you pay them is at the going rate for such work, the tax inspector can’t legitimately refuse a tax deduction.
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.