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Keep it in the family

In recent weeks, I have been looking at the theme of starting up a business in one&#39s latter years. Now, I would like to look closer at some of the strategies that involve one&#39s own family in the business. Planning should be aimed at:

Minimising tax and National Insurance on income.

Maximising the overall benefits received by the family.

Maximising pension benefits for each spouse where suitable.

Regardless of the trading medium chosen for the business, when planning salary payments, due account must be taken of the national minimum wage provisions. If a spouse works for no pay, he or she may not be an employee for the purposes of the legislation. However, as I have pointed out before, an obvious way to make use of an otherwise non-working spouse&#39s personal allowance is to employ them in the business, perhaps in an administrative or secretarial role.

Especially for the older venturers that I am considering in this series of articles, this may well be a realistic proposition. Income can be offset by the recipient against his or her personal allowance and so escape tax and NIC if paid at an appropriate level. It is worth noting that, save for obvious cases of NIC avoidance by “employment splitting”, there is no aggregation of remuneration for the purpose of the NIC threshold. If income paid to the spouse would otherwise have been received by, say, a higher-rate taxpayer, then a substantial tax and possibly NIC saving will result.

This strategy can be effective so long as certain pitfalls are avoided. If a spouse is to be taken on as an employee, remuneration must be commensurate with the work done. If not, even though this spouse will still be liable to tax and NIC (if applicable) on all the remuneration received, the company will not secure a deduction in its accounts for that part of the remuneration deemed to be excessive under the principles of the Copeman Flood case (1940). In this case, the Inland Revenue contested the deductibility of £2,600 a year (£75,000 in today&#39s terms) paid to a pig dealer&#39s daughter for taking phone enquiries.

Obviously, the possibility of double taxation arises through non-deductibility for the payer and assessment of the recipient. If the excess (the non-deductible part) is formally waived and paid back, the Revenue will only tax the deductible part of the remainder.

When paying wages, the following basic principles should be kept in mind:

Wages should actually be paid and be verifiable.

Wages should be documented in the accounts.

The employed spouse should be given a written contract of employment.

Where the spouse is paid not more than £87 a year in 2001/02, not only will both tax and NIC be avoided but they will also qualify for NIC-based social security benefits.

Where the business is a sole tradership, it should be noted that a substantial income tax saving can be achieved through a husband/wife partnership. It is essential that the spouse is admitted properly to the partnership.

There has been evidence that the Revenue has sought to invoke the provisions of s660A ICTA 1988 on the grounds that there has been a settlement of income which is not exempt from the anti-avoidance provisions on the grounds that the settlement is between husband and wife. The Revenue could argue that, if the spouse does not work in and contribute substantially to the partnership, the income they are entitled to by virtue of their partnership interest (in many cases, 50 per cent) is nothing more than a settlement of that income by the substantially involved partner. This partner would then have their spouse&#39s profit share assessed on them.

For incorporated businesses, the Copeman Flood provisions in respect of salary payments and section 660A ICTA can be avoided by making the spouse a shareholder and paying them dividends. The potential risks here have been made clear since the Young Pearce case (1996).

A similar attack, based on the argument that there has been a settlement of income, could also be used by the Revenue where a spouse has shares in the business but those shares only participate in dividends and have no voting rights or rights to capital. An outright gift of shares, with all rights attached, ought not to give rise to a problem.

It is worth remembering such shares can be held in joint names to share dividend income equally, even though the beneficial interest in the shares may be 99/1. S282A ICTA 1988 provides that income from jointly-held assets can be split equally for income tax purposes even though assets are not held beneficially on a 50/50 basis. If a couple wish income to be allocated in line with their beneficial interest in the asset, Form 17 needs to be submitted to the Revenue.

For some business owners, there may be scope to employ children or even grandchildren. There is no prohibition or tax consequence that applies purely by virtue of the relationship. As long as the employment is permitted and the pay justified by actual work done, the settlement provisions can be avoided and the income assessed on the child (and usually be within their personal allowance) and deducted for the payer.

Can the dividend route work for children? They will need to be the beneficial owners of shares if the dividends are to be assessed on them. Where the children are over 18, this should not represent a problem. But if the shareholder is a minor unmarried child of the donor of the shares, care will need to be taken in respect of the possible application of the parental settlement provisions, subject, of course, to the £100 rule. For donors who are grandparents, this rule will not be relevant.

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