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 In this helpsheet we're going to look at the main ways of tax planning with the use of family members...
Paying wages to your spouse and children through your business
Your spouse may not have any income at all, and almost certainly your children don’t. This means their personal allowance of £5,225 (for 2007/08) is being wasted every year. Even children are entitled to a personal allowance.
If this amount was paid to them as wage, they would pay no tax on it and your business profits could be reduced.
Please note that children under the minimum school leaving age can only work a limited number of hours per week and local by-laws may restrict them further
If you pay just 22% income tax and 8% Class 4 National Insurance this would save you £1510 every year on each salary.
And how many children do you have?
STOP! It’s not quite that simple. To pay wages like this you need to follow the following rules...
- It must be for work actually done. Now it’s going to be tough to argue your 2-year-old son is working for you but many spouses/civil partners do work and mature children may also help out.
May be they do the books, answer the phone, stuff envelopes, etc. Keeping out of your way so you can get on doesn’t count, as valuable as it may be. Draw up a list of their responsibilities to help your case. At present they do it for free because it’s a family business but they can be paid for it. If you make your spouse a director, all the responsibilities of this imposed by Company Law must be worth something.
You can also do this where you have property that you rent out and the spouse manages the properties.
It’s reasonable to pay them a salary commensurate with what they actually do. How much would it cost to get someone in to do that job? The minimum wage level is at least a good place to start but more if you can justify it.
- The amount must actually be paid. It’s no good the accountant just putting it through the accounts at the end of the year.
Pay it, ideally through the bank rather than cash so that it’s easy to prove it’s been paid and record it in your accounting records.
- Comply with any PAYE procedures such as getting a P46 signed, completing an end of year PAYE forms as you would do for normal staff. It may also help keep up their National Insurance contribution record even if they don’t pay any National Insurance on the salary.
Making your spouse a partner or shareholder in your business to reduce your tax bill
This is presently very topical with the so called Arctic Systems case involving Mr & Mrs Jones. The case was originally won by the Revenue and but on appeal to the High Court has been won by the taxpayer. It is now going to appeal at the House of Lords.
The basic idea is that income that was going to be taxed on you is now shifted to your spouse who pays lower rates of tax.
Firstly, it may simply be an alternative way of using you’re their personal allowance rather than going down the road of paying a salary. However, this strategy is normally saved for situations where you are paying higher rate tax and you want to avoid this by splitting your profits or dividend income with your spouse/civil partner to use up their basic rate band as well.
For example, for 2007/08 if you earn £70,000 per year, then £39,825 is taxed at basic rates but the remaining £30,175 of this is taxed at 40%. So by it going to your spouse/civil partner, you could save £30,175 x 18%=£5,431 in addition to the saving on their personal allowance.
As with many things in the tax world, it’s not always been simple. The major obstacle the Revenue have been trying to put in the way is what is known as the “settlements legislation”.
In a nutshell this says if you give something to your spouse that is not wholly or substantially a right to income, any income that does arise will be treated as their income for tax purposes.
The argument goes that giving your wife a share in your partnership or some ordinary shares in your company is not just a right to income but also to capital because they now become entitled to a proportion of the assets when the business is closed down or would be on a divorce. Therefore it is not just a right to income.
For many years, accountants up and down the country have been using this so called loophole but it has come under attack from the Revenue in the Arctic Systems case.
The Revenue has published guidance in this area but it does not cover many situations and this was prior to them losing the case.
The main problem can arise where the company is based on the work of just one of the married couple, such as a computer consultant, which was the basis of the Arctic Systems case. The spouse doesn’t work in the business and the company has no goodwill value without the computer consultant or any other assets to give it a capital value.
If your spouse has become a shareholder or partner for legitimate reasons it is safe to do.
It is important that the gift of shares or partnership is an outright gift with no strings attached. Otherwise it will not count.
This can however be one of those grey areas in tax you should get further advice from in your own situation as every case here will be different.
Until the final outcome of the Arctic System case is known, if you do go down this road, it means doing everything you would do if this happened and it wasn’t your spouse. For example, having a partnership agreement, amending bank signatories, letterheads, telling suppliers, the VAT man, etc. If possible, also get your spouse to introduce some money into the business.
The items we recommend looking to put in place to help ensure your case is not challenged are as follows:
- Avoid formal arrangements and contracts of employment.
- Have no pre-arranged policy on salary levels or dividends
make both spouses directors
maximise and document the efforts of the non fee-earning spouse.
- Consider an outright gift of shares to the non fee-earning spouse
before the business becomes profitable.
- Tone down any description of your business activity in your accounts as being a “one man band” – but don’t be misleading. Create a more corporate image.
- Avoid having different classes of shares particularly non-ordinary shares that have less capital value.
- Make the share capital at least £1000.
- Make sure all the paperwork is right and stacks up re companies house forms, dividend resolutions, etc.
- Consider transferring assets to the company in return for a new share issue to uplift the capital base of the company.
- Don’t pay out all the profits in dividends. Leaving 20% in the company increases the impression of capital rather than income.
- Ensure any dividends paid to a non-working spouse are paid into their own personal bank account.
- Appoint the spouse as a director and company secretary and beef up their services as much as possible. Make them the Chairman with the casting vote.
- Transfer the spouse’s income if any into the company to increase their stake in the company.
- Consider giving more than 50% control of the business to the spouse.
Other relatives and non-married couples
For non-married couples, other relatives such as brothers, sisters or grandparents, the settlements legislation does not apply in the same way. The specific loophole applies only to spouses.
However, if the donor (that’s you) retains no interest in the gift, the income will not be assessed on them.
This may be hard to substantiate where you and the donee are cohabiting and share bank accounts and living costs.
Giving investments to your spouse and children
You should also look at your investments to decide if it would be better for your spouse to own them so that the income is assessed on the spouse.
For any jointly held investments with your spouse (other than shares in the family company) they are treated as being owned 50/50 for tax purposes, however actually owned, unless you make an election to the contrary.
Any gifts to your minor children, which result in them receiving an income, will still be classified as your income for tax purposes apart from the first £100 of income each year.
You can however pay up to £1200 per year into a Child Trust Fund, the interest they earn then being tax-free.
How We Can Help You
Family tax planning, especially when treading on the settlements legislation is very complex and we can advise you on the best strategy in your own circumstances.
Got a Question?
If you have any queries on any of the above, please ask a question
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