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Schedule E

Under self assessment it is now relatively easy for the Inland Revenue to question the validity of a wife&#39s (or husband&#39s) wages. This could follow the start of an &#34aspect&#34 or &#34full&#34 enquiry into an individual taxpayer or a &#34purge&#34 by a tax district. A purge could be on a wife&#39s wages or whether personal pensions premiums were correctly claimed.

Two tax cases are helpful to the Inland Revenue. In Moschi -v- Kelly (1952) wife&#39s wages were merely book entries and were never actually paid to her. An appeal against the Inland Revenue&#39s disallowance of the deduction of wife&#39s wages in the business accounts failed. In Abbot -v- Commissioners of Inland Revenue (1995) the taxpayer made an &#34error or mistake&#34 claim under Section 33 Taxes Management Act 1970. He claimed that wife&#39s wages of £10,000 should be allowed as she had done some work for the business even though the wages were never actually paid to her. The claim failed.

Although the Inland Revenue lost the recent tax case of Hitch -v- Stone (1999) on an alleged tax avoidance scheme, the Inland Revenue set out its attitude toward the principle of &#34sham&#34: sloppy record keeping is indicative of sham documents.

Five basic principles should be kept in mind when paying wife&#39s wages.

1. The amount should be commercially justifiable and the services should actively be performed.

2. The wages should actually be paid and be verifiable e.g. by cheque or direct debit.

3. There should be documentation in the accounting records.

4. The wife (as well as other staff) should be given a written contract of service.

5. The wife should be treated the same as other staff regarding Paye As You Earn and pension entitlement.

The adviser should set out the above basic principles based on the legislation and case law at the time in a letter and send it to the client. This should help to protect the adviser in the event of a subsequent Inland Revenue compliance visit or investigation.

The Inland Revenue could claim that an expensive company car for a wife on modest wages is a perquisite of the husband, and no tax relief should be allowed. Similarly, golden hellos and golden handshakes could be caught. The adviser should be able to justify all wages and benefits in their own right and also in comparison with other employees and the going market rate.

As an alternative to employing the wife it is possible to make her a partner. The following documentation is desirable and it would be prudent to keep copies.

1. Notification: A standard letter notifying e.g. clients and suppliers of a new partner should be kept. Brief details of the new partner should be given.

2. Written partnership agreement: this is preferable to a verbal agreement

3. Letterheads and invoices: these should include the names of all the partners, otherwise the Inland Revenue could claim that a &#34sham&#34 arrangement exists.

4. Advertising: clients should be notified of the new partner and be encouraged to contact her.

5. Tax returns: the VAT office must be notified of the new partner to enable it to issue VAT returns in the partnership name. It would be prudent to notify the Inland Revenue at the same time.

6. Legal proceedings: these should be commenced in the name of the partners.

The Inland Revenue could claim that the husband does more work than the wife and so the partnership was set up to divide the profits equally for tax avoidance purposes. It could be countered that the wife is entitled to a half-share of the profits as she shares the risk of repossession of the family home and takes an equal part in the decision making of the partnership. Her time spent at home writing up the books and dealing with administration means she does not have to spend that time at the office. While the husband could have technical expertise the wife could have complementary skills e.g. business and marketing acumen.

Finally, the advisers should recommend that the clients should seek legal advice on the non-tax aspects e.g. if the personal relationship between husband and wife broke down, neither of them could then sue the advisers for inappropriate advice relating to their business relationship.


In advising clients involved in small businesses, financial advisers should clearly be aware of the tax savings available for a married business proprietor using all of the allowances and reliefs available to a married couple. One method of effectively using the personal allowance of a spouse who is not currently working full time is to employ him/her in the business and pay a small salary. This can also have NIC advantages and, of course, another spin off is that the salary is pensionable meaning that more money can be extracted in a tax efficient form from the business, although the days of large EPP contributions are now no longer here.

In addressing these issues, advisers must bear in mind some of the tax rules and tax traps of employing a spouse so that clients are fully aware of the situation in advance of them discussing the arrangement with their accountants before implementation.


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