OCL Accountancy – Paying a salary to a family member

One of the most efficient methods of reducing a company’s tax bill and increasing the amount of cash withdrawn at the same time is by paying a salary to a member of the director’s family. For example, the director’s spouse or children at university.

Employing a family member will also allow them a National Insurance contribution credit towards their state pension entitlement and their salary will count as ‘relevant earnings’ to enable private pension contributions.

Care needs to be taken so that the payments do not fall foul of what is termed the ‘settlement’ rules. The question here is whether by allowing the family member income from the business, they are earning a PAYE salary or whether the owner-director has created a settlement and ‘retained an interest’ in the business.

Should an individual create a ‘settlement’ but retain ‘an interest’, then under this legislation, the income of that settlement is treated as still belonging to the settlor (in this instance, the director).

To qualify as a deduction against the company’s tax on its profits, the family member needs to ‘really’ be earning the amount that is paid to them. The amount paid must be in return for the work they undertake. If no work or little work is undertaken, then HMRC could refuse the company a tax deduction and treat the payment as a distribution to the directory.

Paying a spouse, say, £50,000 a year for one day’s work a week might be challenged by HMRC and, if upheld, would result in the expense being disallowed as not being incurred ‘wholly and exclusively’.

The salary must be reasonable for the work undertaken – salary greater than would be paid to another non-family member to do the work could be investigated by HMRC. By appointing the family member as a director, a small salary could be paid, even if the actual work undertaken is little.

Paying the ‘optimal’ salary amount of £12,570 also means that the family member has a year’s NIC contributions towards their state pension without having to pay any employee’s NIC, although this could also be achieved if a salary equal to the lower earnings limit of £123 per week (£6,396 a year) is taken.

The salary could be paid into the family member’s personal bank account and recorded in the accounts as payment to another employee; the company will also need to comply with the Real Time Information requirements of a payroll scheme. Should the family member also be a shareholder, there will also be the option of withdrawing more from the company if needs be.

For more information contact OCL Accountancy – call Tristan Wilcox-Jones, Samantha Taylor or Lucas Knight on 01225 445507