05 Dec Can I employ a family member?
As with claiming a tax deduction for any business expense, a salary must be paid on a commercial basis, wholly and exclusively for the purposes of business. It follows that if you employ a family member to carry out a function of the business; firstly, they must actually be working within the business; and secondly, the amount paid to them must be no more than would be paid to a third party in a transaction entered into at arm’s length. Paying a salary for purely tax-motivated reasons is unlikely to stand up to scrutiny in the event of a HMRC enquiry.
The acid test for this is whether you would offer a complete third party, outside of your household or family, the same rate of pay for the same amount of time and the same task – so if you are considering paying your husband, wife or child £50 an hour to answer your phone, fold letters or scan receipts – consider if you would pay me, or anybody else that you don’t really know, the same amount of money to complete the same tasks.
The completion of admin work is the most common type of work that we are asked about. The nature of admin work required by single-person companies is minimal, in most cases rarely over a couple of hours each month and the rate commanded on an open market is unlikely to be more than £10 per hour. For this reason, in single-person businesses we suggest that for the sake of £20 per month that it is not worth having to later justify this to HMRC, should they make an enquiry into your tax affairs. As with anything there will, of course, be exceptions to this rule, as different businesses have very different requirements for administrative work.
A better, and tested, way of utilising the tax allowances of a spouse, and only if you they are a spouse/civil partner who you are living with (this doesn’t cover children etc.) is to gift shares to them, entitling them to a portion of dividends paid by the company. Of course, this comes with conditions too, and is only worth considering if the highest rate of tax that they pay is lower than the highest rate of tax that you pay (i.e. there is no point in transferring one higher rate tax liability to another higher rate tax payer, whereas there would be a benefit in transferring to somebody whose income will not exceed the higher rate threshold).
It is well established that the transfer of an asset (including shares in a private company) to a spouse will not be liable to Capital Gains Tax – this is known as the spousal exemption, and only available to couples that are married/civil partnered – it is not available for gifts to unmarried couples, children, parents etc. Shares gifted (i.e. transferred at no cost, or for less than their market value) outside of marriage will be subject to Capital Gains Tax on the market value of the shares, had they been sold on an open market basis to an unconnected third party – bringing about the question of how they are likely to be valued.
Shares in a private company are not traded on a public market (i.e. a stock exchange), and the value of the shares is simply what is agreed between the buyer and the seller. HMRC could take an interest in any share transactions which they deem to take place below what they consider to be market value, particularly if the shares are traded between connected parties (such as unmarried couples or other family members). The value that HMRC attribute to them could be anywhere between the net asset value (from the balance sheet) to the net present value (i.e. discounted to account for inflation) of future cashflows (dividends) – the value on this spectrum will depend on a whole host of factors, such as:
- the industry that the business operates;
- the outstanding value of contracts/committed revenues;
- diversity of revenue (i.e. how many sources is revenue from);
- average customer tenure/lifetime value;
- market share or reputation;
- growth rate;
- strength of management team; and
- operational maturity of the business.
With the above in mind, we always recommend seeking professional advice from your accountant before transferring shares – generally it is best not to transfer shares to a connected party other than a spouse, unless a genuine commercial reason exists (such as to secure funding for a project etc).
The scenario of a spouse owning shares in a company has been tested in the courts, the test case of the Settlements Legislation is Jones v Garnett – better known as Arctic Systems. During this case, HMRC (Garnett) argued that – in Geoff Jones giving away half of the shares in his IT contracting company, Arctic Systems, to his wife – the dividend income paid to her created a “settlement” which was in breach of S660A, and the income paid to his wife should therefore have been taxed as if it had been paid to Geoff.
This case went to the highest court in the UK legal system at the time, The House of Lords, who went in favour of the tax payer. This created a binding precedent for any subsequent cases heard in that or any lower court of the UK legal system – this means that if HMRC were to bring another case with an identical set of circumstances to a lower court then the outcome of the case should be identical – however differences in circumstances would not be covered by this precedent, and therefore could be open to challenge.
This judgement therefore means that companies that are jointly owned between spouses are not caught by the settlement’s legislation, and that this method of reducing the tax liability of business owners remains valid, for the time being at least.