The tax risks of paying your partner
Michael Lansdell explains the implications.
A friend has suggested you follow their 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?
There have been a number of court rulings in which a tax deduction was refused because they were only book entries: 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 related to you. If they are an employee, give them an employment contract. If they work for you freelance, there should 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!
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 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.
McAdam v HMRC 2017
The “wholly and exclusively” point was considered in a 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, and other admin tasks. The FTT refused the deduction, because it said the payment was excessive compared to the going rate for the type of work. Plus, the 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 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 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 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.
Want to know more? Give us a call at Figurit on 020 7376 933. We’ve got the experience and knowledge to keep you compliant with HMRC and help you be more tax efficient.