Mark McLaughlin looks at wages payments by the self-employed to their offspring, and whether claims for a tax deduction are allowable.
It is not uncommon for the self-employed to enlist a family member (e.g., offspring studying at university and earning spending money at weekends) to help in the business occasionally.
How much can the parent reasonably pay?
To be an allowable business expense in such circumstances, wages payments to the family member must be ‘wholly and exclusively’ incurred for the purposes of the trade (NB. an identical rule applies to companies, but this article focuses on unincorporated businesses).
Don’t go overboard!
HM Revenue and Customs (HMRC) will sometimes look at the level of payments to the family member and seek to establish whether the remuneration paid significantly exceeds market rates. HMRC’s guidance (in its Business Income Manual at BIM37715) indicates that whether wages to the family member are ‘excessive’ (and therefore not a tax-deductible expense for the business owner) will be determined on the particular facts.
However, HMRC instructs its officers: ‘You should accept a deduction for remuneration that is commensurate with the duties undertaken and at the rate payable on an arm’s length basis by comparable employers.’
What’s the purpose?
If the wages payments (to the business owner’s university student offspring, in the above example) are considered excessive, HMRC might (if there is no clear connection between the payments and the work performed) argue that the whole amount should be disallowed.
However, if there is duality of purposes, a deduction is not prohibited for any identifiable proportion of the expense which is incurred wholly and exclusively for the purposes of the trade (ITTOIA 2005, s 34(2)). In such cases, only the excess above a normal commercial rate should be disallowed, on the basis that there is a ‘non-trade purposes’ for paying the excess (see BIM37707), such as out of parental love and affection.
Cases where a trader’s wages payments to offspring were considered to be excessive include:
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Nicholson v Revenue and Customs [2018] UKFTT 14 (TC) – Wages payments to a self-employed individual’s son (a university student) were wholly disallowed. The First-tier Tribunal (FTT) held that the payments had a dual purpose and were not incurred wholly and exclusively for the purposes of the taxpayer’s trade. They were not directly and solely referable to the trade. There was no direct relationship (arithmetically or otherwise) between the amount of work his son did and the payments he received; the taxpayer was helping to support his son whilst at university.
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Johnson (t/a Johnson Bros & Co) v CIR [1919] 12 TC 147 – Increased payments by a trader (i.e., in terms of a share in the profits of the business) to his three adult sons were held to be excessive and were therefore partly disallowed for tax purposes.
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Scott & Ingham v Trehearne [1924] 9 TC 69 – Commission payments to a trader’s two sons (at a rate of 33.33%) were not considered to be on a commercial basis, and only 10% was deductible.
Practical tip
Self-employed individuals paying wages to a family member should do so with care. The tribunal in Nicholson commented that had the taxpayer paid his son on a more time-recorded basis or had there been some form of methodology in calculating the amount payable and an accurate record maintained of the number of hours his son worked, it was unlikely that the expense would have been disallowed.
