If you are in business on your own account, have you considered the tax advantages of employing your spouse? If you already do this, are you avoiding the tax traps that could cause you problems?
Let's start by looking at the potential tax advantages. At its simplest, the aim is to ensure that your spouse receives tax-free income of about £4,700 per year. This could save the family anything from £1,034 to £1,880 per year if the money would otherwise have been part of your taxable income. The income will only be tax-free if it falls within your spouse's personal allowance for tax purposes. This assumes, therefore, that your spouse does not have any other taxable income.
Let's look at the position of Gordon and Sarah, who are both involved in the family catering business. Gordon is the "main man", but he relies on Sarah's support and assistance. She doesn't have any income of her own. Gordon earns about £36,000 per year but doesn't currently pay Sarah anything for her contribution to the business. After all, they live together and both spend the money that Gordon earns. What difference would it make?
Well, in round-sum terms, Gordon's tax bill on his earnings of £36,000 will be about £6,414. If he paid Sarah a salary of £4,700, then his tax bill would fall by more than £1,000, but Sarah would have no tax to pay on her £4,700 salary. This is because it falls within her personal allowance. As a family they would save more than £1,000 a year (at current rates).
Additional tax savings are possible if Gordon's income is higher and subject to tax at 40%. He might be able to redirect further income to Sarah, who would pay tax at lower rates on anything up to £31,400, in addition to the £4,700 noted above. The maximum tax savings in such a case are almost £5,900 per year. If you are in business, you too can achieve this in one of the following three ways, depending upon the type and structure of your business:
- Pay a salary for work done by your spouse.
- Pay a dividend on shares owned by your spouse.
- Share profits with your spouse (in a partnership).
There is another benefit to some of these arrangements, too. If your spouse is paid a salary of between £4,108 and £4,745 and has no other earned income, then no national insurance contributions will be due. However, even a salary at this level will count towards state retirement pension and state benefits.
Sounds good, doesn't it? So what could go wrong? Well, if the Inland Revenue suspects a "fiddle", there will be back taxes, interest and penalties to pay. The total could easily mount up to something between £40,000 and £50,000 over a six-year period. Clearly it's important to minimise the prospect of such a problem. This means you must do things properly, and don't get greedy.
If you pay a salary for work done by your spouse, it is important that the work really takes place. The Revenue may seek evidence to prove that your spouse was working in the business. You need to keep good records to evidence the work done and the hours worked each week.
Dividends are paid to shareholders, so there is no need for any work to be done in return for the receipt of dividends. Partnership profits need not be shared by reference to relative contribution or work. However, it is best if both partners are actively involved in the business.
If you are a sole trader, or if your business is carried on through a company, you will want to pay your spouse up to £4,745 (this year). You can then deduct this from your taxable profits. But you do need to be able to evidence the fact that the payment has really been made. You should not expect the taxman to accept your claim to tax relief for salary payments that you haven't physically paid to your spouse. Cheques are probably the best way to ensure there is evidence of payment, both of salary and of dividends. Partnership profit shares will be reflected in the business accounts, and "drawings" should be paid out separately to each partner.
Keep the paperwork
Dividend payments should be recorded on "vouchers" that your accountant can probably supply. Dividends should also be properly voted and recorded in the company's minute book.
Salary payments should go through a PAYE scheme even if no tax is payable, and the annual forms should be retained for tax purposes. Partnership profit shares will be reflected in the accounts.
Avoid a "settlement"
In April 2003 the Inland Revenue announced that it did not approve of "settlements" between husband and wife, or between other couples or family members. This specifically affects situations where one person gains a tax advantage by making a gift which is principally a "right to income". The Revenue is specifically concerned with situations where it believes there is an arrangement to divert income from one spouse to another.
The taxman's current view can also affect disproportionate profit shares in family business partnerships. It is now more important than ever to seek advice from a professionally qualified accountant before rearranging your affairs to pay dividends to a spouse or to have them join you as a partner in the business.
National minimum wage
If your spouse works for your company, you should be paying at least £4.50 per hour (£3.80 if your spouse is under 22 years of age). This rule does not apply to dividend payments or if you are a sole trader or in partnership. It also does not normally apply if your spouse is a director of the company.
All the tax and national insurance advantages noted above apply equally where the two people are not married. So don't feel you have to miss out if you're not married to your partner. Of course, the tax traps are still there to be avoided. If in doubt, do make sure you take advice. You never know, your accountant may have first-hand experience of just this type of arrangement with his or her own spouse.
Mark Lee is managing director of the London office of chartered tax advisers Shaw & Co.