Having a spouse or your children on the payroll of your business can be tax effect as long as HMRC will wear it. Where do you stand if the taxman challenges your claim for a tax deduction?

Tax deductible or not

A particular area of contention between businesses and HMRC is whether an expense has been incurred ‘wholly and exclusively for the purpose of the trade’. No tax deduction is allowed if it hasn’t. Questions will often follow from a tax inspector if there are payments in your payroll or accounting records to a spouse, or other family member.

Justifiable expense

HMRC will first want to establish that the family member actually works and is not being paid just to get money out of the business. It will then assess whether the work they do justifies the salary you’re paying them. HMRC’s internal manual states ‘So where there is equal pay for equal value, the amount paid is fully allowable, notwithstanding any connection between payer and recipient’.

Tip. Keeping accurate records will go a long way in persuading th tax inspector that the salary paid to your spouse or child is legitimate.

Getting what you pay for

Aim to pay the family member the going rate for the work they do and no more. If they are your only employee or have a unique role in your business, determining what the right level of pay is can be tricky.

Tip. If in doubt, speak to your accountant as they’re likely to have experience of similar situation and should be able to suggest a suitable rate of pay.

Trap. If, despite your efforts, you have to concede a reduction in the amount you claim as a deductible expense, remember that any corresponding PAYE tax and NI that has been paid is not refundable.

Job creation scheme

It’s important to understand that HMRC has no grounds to disallow a deduction just because a tax inspector thinks the job your family member does isn’t necessary. For example, you could create a job for your son during the summer break from university to valet the directors’ cars or to reorganise the stationary cupboard and other areas of the office. Provided what you pay him is at the going rate for such work, the tax inspector can’t legitimately refuse a tax deduction.

Tip. Creating a job in your business can be a tax efficient way to put extra cash in your youngster’s pocket that you might otherwise have to pay out of your taxed income.