14 July 2023
In today’s competitive business landscape, it is crucial for companies to explore strategies that can help reduce their tax liabilities while optimising cash flow. One such strategy is paying a salary to a member of the director’s family. This article aims to shed light on the benefits, potential tax traps, and practical considerations associated with this approach.
Benefits of Employing a Family Member
By employing a family member, such as the director’s spouse, civil partner, or children at university, companies can reap several advantages beyond tax savings. For instance, employing a spouse or civil partner enables them to accumulate National Insurance Contribution (NIC) credits towards their state pension entitlement. Furthermore, an employee’s salary counts as “relevant earnings,” enabling them to make private pension contributions.
Understanding the ‘Settlements’ Legislation
While paying a salary to a family member can be advantageous, it is essential to navigate the potential pitfalls associated with the ‘settlements’ legislation. This legislation exists to prevent income from being diverted to family members who may be subject to lower tax rates, commonly known as “income splitting.”
The settlements legislation assesses whether the owner-director has created a settlement and “retained an interest” in the business, leading to the income being treated as belonging to the settlor (i.e., the director).
However, outright gifts of income-producing assets to family members, carrying a right to the whole income and not solely or substantially a right to income, are exempt from the settlements rules.
Determining the Appropriate Salary
To qualify as a deductible expense against the company’s tax on its profits, it is important to ensure that the family member is genuinely earning the amount paid to them. HMRC may scrutinise payments that appear excessive relative to the work undertaken or lack thereof. It is recommended to pay a reasonable salary comparable to what a non-family member would receive for similar work.
The ‘optimal’ salary amount is influenced by factors such as National Insurance Contribution (NIC) thresholds. For instance, in 2023/24, the ‘optimal’ salary is £12,570, as NIC is not payable by the employee on the first £12,570. Although the employer is liable for NIC on the amount exceeding £9,100, the corporation tax relief on the entire salary plus employer’s NIC outweighs the NIC liability.
Practical Tips for Implementation
When paying a salary to a family member, certain practical considerations should be considered:
- The salary should be paid into the family member’s personal bank account and clearly documented in the company’s accounts as payment to another employee.
- The company needs to comply with HMRC’s Real Time Information requirements of a payroll scheme.
- If the family member is also a shareholder, additional withdrawals from the company may be considered if necessary.
Conclusion
Paying a salary to a family member can be a highly effective strategy for reducing a company’s tax bill. However, it is important to understand the potential tax traps, navigate the settlements legislation, and ensure that the salary paid is reasonable for the work undertaken.
By seeking professional advice and adhering to the guidelines provided, businesses can utilise the benefits of this approach and comply with relevant tax regulations.
Contact Morrissey Chartered Accountants today to discuss Paying a salary to a family member.