Putting your partner, husband, wife, children or family friends on the payroll of your business can be tax efficient.
Paying a close relative or friend through your business does not mean that their wage or salary is automatically allowed for tax purposes.
HMRC can challenge the cost that you put through your accounts where you try to claim a tax deduction.
The tax rules
The main tax rule that you must consider is whether or not you have incurred the expense ‘wholly and exclusively for the purpose of the trade’. This is the general rule for claiming most business expenses. If you cannot answer this question with a ‘yes’ then a tax deduction most probably is not available to you. Wages payments or other amounts paid to family members are often areas of interest to HMRC.
Justifiable expense
You will need to satisfy HMRC that the family member actually works in the business and is not just being paid to get money out of the business and save business tax. You will have to satisfy HMRC that the work that they do justifies the salary that you are paying them.
As for any business, keeping good records will significantly help you persuade HMRC that the amount paid to the employee or family member is fair. For example:
keep the same employee records that you would for any other employee, including providing them with a contract of employment
include them on your payroll and actually pay them, i.e. the salary should not be just a bookkeeping entry
when they first start working for you follow the usual P45 or P46 new starters rules
offer an auto-enrolment workplace pension.
Pay a commercial rate for the job
Pay the family member a commercial rate for the work that they do for you; and no more.
If the amount that you pay to the individual is too high, and it is successfully challenged by HMRC, then they will still be taxed on the higher amount received even though the business’s cost will be restricted. In addition, any corresponding PAYE/NIC that you pay cannot be refunded.
Create a new job
HMRC have no grounds to disallow a deduction just because they think the job your family member does is not necessary. You could create a new temporary job in the school/university holidays in order to keep the office tidy or assist with some administration.
So long as the rate of pay that you pay to the individual is at a commercial rate for that type of work then HMRC cannot restrict or refuse a tax deduction on the cost of the wages.