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Tax deductions for family members' wages?

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Newsletter issue - March 2018.

Many adults are likely to embrace the offer of help with technology from the younger generation! So where a child is employed in a family business to work on, say, website creation, management and social media, how can the owner make sure that their wages will be tax deductible? The recent case of Nicholson v HMRC (TC06293), in which the first tier tax tribunal examined a deduction made in sole trader's accounts for his university student son, gives us some pointers.

In this case, Mr Nicholson claimed that his son had been employed in promoting the business through internet and leaflet distribution and computer work. His wages had been calculated at a rate of £10 per hour for 15 hours per week, but unfortunately there was no evidence to support wages being paid on this basis. HMRC rejected the claim because of a lack of contemporaneous records preventing a successful reconciliation from the business bank statements.

Mr Nicholson claimed that payments to his son had been paid partly through the 'provision of goods'. He managed to identify £1,850 in cash by reference to his son's bank statements. He also substantiated a monthly direct debit of £18.51 in respect of his son's home insurance costs. However, the bulk of the claim was based on Mr Nicholson buying food and drink to help support his son at university.

The tribunal made reference to an earlier judgement in Dollar & Dollar v Lyon (HM Inspector of Taxes)[1981] CH D54 TC 459, which also involved payments to family members, and concluded that Mr Nicholson's payments were made out of 'natural parental love and affection'. There was a duality of purpose as the 'wages' had a major underlying 'private and personal' motive, and thus not for the purposes of the trade. The tribunal subsequently dismissed the appeal on the grounds that Mr Nicholson was doing nothing more than supporting his son at university.

In particular, this case highlights the importance of keeping proper records regarding the basis in which payments are to be made to children. The tribunal commented that the likelihood of a successful claim would have been increased had there been payment on a time-recorded basis, or a methodology in calculating the amount payable plus an accurate record of the hours worked. A direct link between the business account and the recipient's account would clearly be advisable.

Whilst there was no suggestion here that employing relatives is an issue in itself, the importance of paying a commercial rate for the work undertaken should be noted. The concept of 'equal pay for equal value' should help prevent a suggestion of dual purpose and thus, in turn, also help refute allegations of excessive payments to family members as a means of extracting monies from the business.

Finally, wherever payments are made to family member, legal issues such as the national minimum wage should also be borne in mind.