FAMILY PAYROLL PRECAUTION
IONCE WENT to meet a potential new client, only to find that all of the owner’s family were paid on the books but never turned up to work — and yet everyone who actually worked in the business was paid off the books.
I shall not deal with the latter scenario in this article. Suffice to say that paying cash to employees is illegal and should now be a thing of the past. HMRC’s armour is increasing and the consequences of not putting employees through the payroll are increasingly serious.
However, it is worth reminding ourselves about the tax consequences of employing family members. Is it legal to employ relatives and do they actually have to turn up to work, or can I “just put my kids on the books”?
In a recent tax case heard by the firsttier tax tribunal, Colin Nicholson was disallowed a claim of £7,400 for wages paid to his son Mark, for his time spent “promoting the business through the internet, leaflet distribution and computer work”.
The first point of note is the amount involved. Often people perceive that HMRC will have no interest in taking on small cases. This is untrue. HMRC will pursue a case which it thinks carries an important point of principle, which may not have a large amount of tax at stake.
Nicholson claimed his son’s wages had been calculated based on a rate of £10 per hour and that he worked approximately 15 hours per week. HMRC did not suggest the rate of pay was inappropriate, nor did it claim Mark was not actually working for the business, nor that he did not have the requisite skills to carry out the work described.
Although the tribunal rejected Nicholson’s claim, it is valuable to reflect of the points raised in the case, because it is clear from the judge=ment that, had the payments been better planned and documented, it might have succeeded.
First, the tribunal heard that Nicholson did not pay his son directly to his bank account. Instead, on occasion he settled his son’s bills or paid for his university food. Had Colin paid a monthly amount directly to Mark, it would have looked more like a payment for services.
Second, there was no record of what work was done by Mark and how long it took.
If Mark had kept a current record of time spent and submitted it to his father periodically, following which payment was made back to him, it would have again looked more like a fee or a wage. The fact there was no contract for the amounts payable, or a clear trail of how those amounts were calculated, indicated these were not real payments for work done.
Third, using the money to settle Mark’s private bills indicated to the tribunal that the reality of the situation was that Colin needed to financially support his son, but thought he could get a tax deduction for it. While in itself there is nothing wrong with directing a payment to the place an employee requests, in this instance it persuaded the tribunal that HMRC, which thought these were private payments, was indeed correct.
In my experience of working with small and medium-sized businesses, many family members will help out the business with advice, administration, marketing or working at the shop on a Sunday morning — and often without proper recompense.
Anyone who works in a business is entitled to a fair wage which will be tax-deductible against business income. However, to be sure of getting the relief, you need to make sure the basis of working and the rate of pay is agreed, preferably in writing; that the business actually pays the workers into their own bank accounts and that there are good records of what work was carried out and how long it took. A little planning and documentation at the time will save a big headache — and equally big tax bill — later on.