Dear

Paying family wages

As you know, we keep our eyes open for any information which we think might be useful to you in avoiding problems in the day to day running of your business and wherever possible we pass this on to you.

Many business people either do employ or consider employing family members in their business. This can have many advantages from both a tax and commercial point of view but it is necessary to be aware of various practical matters which have to be taken into account to avoid problems with the tax inspector.

We are enclosing an article which we have recently come across which summarises these practical issues. If there are any matters you would like to discuss with us, please don't hesitate to get in touch.

Yours sincerely,

Name of Practice

Family wages (practical matters)

It is perfectly acceptable to employ family members in a family business but the Revenue will always look closely at the arrangements to ensure that the wages paid are a genuinely commercial expense. They will be particularly concerned to establish that the payment of wages is not for tax avoidance purposes.

Listed below are some of the practical matters to be taken into account when employing family members.

Commerciality

When fixing the amount to be paid to a family member it is important to be able to show that the payment reflects the commercial value of the work done in return. The employer should aim to exclude as far as possible all unquantifiable elements, such as "his or her contribution to the business is beyond measure", and stick to objective criteria. That is not to say that wages cannot be kept under review so that if, at a later date, it really can be demonstrated that the family member is an invaluable employee that the business cannot afford to lose, the wages can be increased to reflect it.

At the outset, it would be advisable to list the work and responsibilities and then try to categorise the job so that it can be compared with comparable ones advertised in the local press or Job Centres. In this way, a commercial hourly rate can be established to be applied to the number of hours worked to arrive at the weekly wage.

It should be remembered, however, when determining the number of hours worked, that the Revenue is unlikely to be impressed by hours spent ironing or mowing the lawn when the family member was "on-call" and available to take business calls.

The acid test is, what would you pay if the employee was not a family member and what would you expect in return.

Keep records

How much easier it would have been for Ian Duncan Smith if his wife had kept a record of the work she had done and the hours spent on it. How much easier too to rebut a Revenue challenge to the allowability of family wages if a full record has been kept of the work done and the hours.

If it would be normal for an employee to keep time sheets for billing purposes etc, the family member should do so. If such formal records would not normally be kept then ensure that any work done can be identified as done by the family member. For example, letters typed should include a reference which identifies the typist.

If there are no formal records because of the nature of the work, keep whatever will show that the family member has actually worked. For example, a boarding kennel might have a rota for dog walking. Ensure this is written out and retained, together with the rota for cleaning the cages, feeding the animals etc.

Such records will help to justify a deduction against profits for wages paid to family members in the face of a Revenue challenge. If the Revenue can successfully sustain their case that the wages paid were excessive, and therefore not a commercial expense, good records will, at the very least, help to justify an apportionment of the wages so that part, at least, would be allowable.

Pay the wages

For wages to be allowed as a deduction in computing the profits or gains of a trade, the provisions of FA 1989, s.43 (as amended by ITEPA 2003, Sch. 6, para. 157) must be satisfied. Under this section, no deduction is allowed for wages charged in the accounts unless they are paid before the end of nine months after the end of the accounting period. Making a provision in the accounts, therefore, is not sufficient.

The section goes on to state that, if the profits of the trade are calculated before the end of the nine month period, it must be assumed that the wages will not be paid before the end of that period. If they are in fact paid before the end of the period, the calculation should then be adjusted accordingly, provided a claim is made within two years of the end of the accounting date.

If the wages are paid after the end of the nine month period, they will be allowed in the period of account when they are paid.

For the purposes of the section, wages are paid when they are treated as received by the employee in accordance with ITEPA 2003, ss. 18, 19, 30 or 31, that is when they are actually paid or when the employee has an unrestricted right to draw them.

Operate PAYE

All the PAYE records which should correctly be kept for any other employee should be kept for family members employed in the business. A failure to do so will result not only in a challenge to the authenticity of the payment but may, in itself, lead to a full enquiry.

Maintaining a P11 for the family member, even if the wages are below the personal allowances threshold, including them on the P35 and completing a P60 will help to distinguish payments which are remuneration from drawings taken from the business. Also, where the payment is between £4,004 and £4,615 (current figures), the proper completion of PAYE records will ensure that, even though no NIC is payable, the employee will be treated as having paid contributions towards a pension and other benefits.

The family member will also be able to be provided with benefits in kind in his or her own right, with a separate calculation of the £8,500 limit stipulated by ITEPA 2003, s.217.

Investigation settlements

If an investigation has uncovered undisclosed cash takings, the taxpayer may say that some of the amount concerned was not taken as drawings but was paid to a family member as wages. It would be most unusual if there were any evidence that the money was paid for this purpose and the usual criteria for satisfying the Revenue that a deduction can be allowed from the profits or gains of the trade are unlikely to be met.

By concession, however, the Revenue may accept that a deduction may be made if they are satisfied that the family member did actually provide services to the business and that the remuneration claimed represents a commercial wage for the work done.

If a claim is accepted, the Revenue will expect to be provided with a written undertaking that no later claim will be made when the wages in question are actually paid.

National Minimum Wage

a. Company Directors

Unless they have a formal contract, which would make them "workers" for the purposes of the National Minimum Wage Act (NMWA), company directors will normally be outside the provisions of the Act. It would be accepted that their work would be done as "office holders" rather than "workers".

If, however, there is a written contract, the director will fall within the NMWA.

b. Family members living at home

There is no need to pay the national minimum wage to family members who live at home and work for the family business.

Summary

If the practical matters set out above are observed, employing family members should not cause a problem. A failure to take account of them, however, will be very expensive.

An uncommercial wage will:

• be disallowed in the accounts of the business;
• remain chargeable to tax as employed income of the employee; and
• give rise to a possible charge to tax under s.660A.

As can be seen, this could give rise to three simultaneous charges to tax on the same amount. The charges to tax could also attract interest and penalties.