Remuneration of wages and pensions to family members
Paying salaries and pension contributions to spouses or
close relatives in a business can be legitimate, but this is a grey area and
has historically been of interest to HMRC. If one spouse is the company's
primary revenue driver and other paid parties appear to do little or nothing in
the business, then HMRC could query the expense payments.
HMRC's Business Income Manual, specifically sections BIM37740
and BIM47105, guides how wages, pension contributions, or other
benefits are treated for tax purposes.
Wholly and exclusively
Being related to the business owner doesn't automatically
disqualify a person from receiving wages that can be claimed as a business
expense. The critical factor is whether the payment is "wholly and
exclusively" for the business.
Excessive Payments
Problems arise if the payment is higher than what an independent person would receive for the same work. If a spouse or relative is paid more than others in similar roles, HMRC might consider this excessive and disallow part of the expense. This could happen if the payment reduces taxes rather than pay for genuine work. Directors are not subject to the national minimum wage rules and a director's salary, that is typically set at the personal allowance of £12,570, would therefore be more difficult for HMRC to disallow as excessive.
The HMRC guidelines emphasise that the relationship between the payer and the recipient should not influence the amount of remuneration and instead the payments should reflect the value of the work performed. If the salary or wages paid to a spouse or relative are in line with what would be paid to an unrelated third party for similar work, the payment is likely to be allowable for tax purposes.
Case Law and Precedents
Court cases like Copeman
v William Flood & Sons Ltd and
Earlspring Properties Ltd v Guest show how excessive payments to relatives have been
handled in the past, often resulting in parts of the payments being disallowed.
Copeman v. William Flood & Sons, Ltd (1940) establishes that
remuneration paid by a company must be wholly and exclusively for the purposes
of the company's trade to be allowable. In this case, a company paid
significant sums to the director's children, aged 17 and 23, who worked in the
business and whose roles and responsibilities did not seem to justify the high
remuneration. The court held that while a company can decide how much to pay
its directors, the amount must be directly related to the business's needs. The
case was sent back to determine how much of the remuneration, if any, was justified
as an expense for the company's trade. The ruling emphasises that excessive
remuneration unrelated to the company's trade is not allowable as a deductible
expense, and decisions on such matters are based on the specific facts of each
case.
Earlspring Properties Ltd v Guest (1995), where remuneration paid
to Mrs Conchita Broomfield, the company director's wife, was significantly
increased after her marriage. The court held that the payments were not wholly
and exclusively for the purposes of the company's trade, as they represented a
diversion of income for fiscal advantages. This ruling underlines the
importance of ensuring that any payments to spouses are justifiable as
legitimate business expenses.
Practical Tips
A hypothetical example
Mr Smith is the sole director of his consultancy company,
which makes £250k profits a year. He pays himself an annual salary of £12,570
and a pension package of £60k yearly. He also takes dividends of around £35,000
a year to avoid paying higher rates of tax. His company cash savings account is
building up, and he is frustrated at paying 25% corporation tax. A friend has
advised making everyone in his family directors and paying them salaries and
pension contributions to reduce his tax and release cash into the family.
His wife, Mrs Smith, works full-time as an engineer and
earns £60k a year. Her employer matches her 5% salary contribution into a
pension (£3k+£3k). Mr Smith makes Mrs Smith a director and tops up her pension
fund with a £54k pension contribution to maximise her annual allowances of
£60k.
The Smiths also have two children who recently turned 18
and have gone to university. He makes them both directors and enters them on the payroll for £12k a
year. He doesn't actually pay the salary to the children but transfers it straight to their university to cover their tuition fees. He also makes a pension contribution of £11k
into each of their pension funds.
Mr Smith now has reduced his profits by 2 x £12k=24k, 2 x
£11k =22k and £54k = £100k expenses. The company has paid significantly less
corporation tax, and everyone in the family is better off.
However, HMRC has
just opened an inquiry into the Company corporation tax return, and Mr Smith is
concerned. Would he be able to justify these salaries and pensions to HMRC as
wholly and exclusively for the benefit of the business and that none of the payments
are excessive?
Conclusion
Paying wages to a spouse or close relative is acceptable to HMRC if done correctly. However, the payments should be fair, for real work, and well-documented to avoid issues with HMRC. At Sherwin Currid, we cannot say whether a pension contribution or salary is excessive, and we do not ask for evidence of work performed. There is no amount or percentage that HMRC can hold a company's remuneration package to be, and each case will depend on the specific facts of the case.