A friend has suggested you follow his lead and pay your other half through the business to reduce tax on its profits. While this can work it won’t in all situations. Is it something you should consider?
Paying your partner
Your bookkeeper’s view is probably founded on a number of court rulings in which a tax deduction was refused because they were only book entries, i.e. they were recorded as expenses but the cost wasn’t actually incurred or the wages paid. The trouble is that even if these conditions are met, it doesn’t guarantee a tax deduction as not all genuine business expenses qualify for tax relief.
Obligations and paperwork
There must be an obligation to pay someone for goods or services that are used in your business. In the context of wages there will usually be paperwork to evidence this.
Tip. When a family member works for your business apply the same principles as you would if it were someone not connected to you. If they are an employee, give them an employment contract. Or if they work for you freelance, there should either be a formal contract or an exchange of letters confirming the services they’ll provide. With the documents in place you have half the battle won, but you’re not in the clear yet.
Taxing conditions
If there’s obligation to pay your spouse, there’s another hurdle to clear if you want a tax deduction. You need to show that the expense is, in the words of the law, “wholly and exclusively for the purpose of the business” . This rule applies whether you run your business as a sole trader, partnership or through a company. HMRC is fond of using this rule to deny tax deductions for all sorts of expenses.
Trap. HMRC will argue that an expense is not wholly and exclusively incurred if the rate you pay your spouse is excessive for the type and amount of work they do.
Tested by tribunal
The “wholly and exclusively” point was considered in the recent First-tier Tribunal (FTT) case of McAdam v HMRC 2017 where a plumber claimed a deduction for £90 per week to his wife for writing up his books, taking phone calls, processing orders, etc. The FTT refused the deduction. It said the payment was excessive compared to the going rate for the type of work, plus the plumber’s business records were poor and there was nothing really to show how much work his spouse did or that she was employed at all. A contract of employment would have helped, but probably not rescued, the situation.
Tip. HMRC is invariably sceptical about an expense for “spouse’s wages” included in accounts. We’re not suggesting you hide anything, but paying your spouse should not be any different from paying any other employee. Using the term “spouse” or similar just flags the issue and almost shouts at HMRC to look closer. “Wages”, “salary” or something similar is a sufficient description.
All or nothing
Interestingly, HMRC had accepted a deduction for about half the amount McAdam claimed. This was generous as the law only allows a partial deduction where an “identifiable part or identifiable proportion” of an expense meets the wholly and exclusively condition. Strictly, it should be all or nothing. So keep proper paperwork, actually pay the wages and at a realistic rate and you’ll be fine.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.