A common element in the accounts of many self-employed individuals (and partnerships) is a deduction for the wages of family members, particularly a spouse (or civil partner). For example, in over 30 years as a tax practitioner I have seen countless claims for ‘wife’s wages’.
Most claims for deductions of this nature are valid and commercially justifiable. However, in some cases deductions are seemingly claimed routinely and on an arbitrary basis (e.g. £100 per week, or an amount just below the threshold at which National Insurance contributions become payable, or possibly at a level to utilise the spouse’s personal allowances). In such cases, it is important to remember that no deduction is allowed to the business proprietor for expenses unless they are incurred ‘wholly and exclusively’ for the purposes of the trade (ITTOIA 2005, s 34(1)(a)). An identical rule applies to companies (CTA 2009, s 54(1)(a)), which are beyond the scope of this article.
Disputes between taxpayers and HM Revenue and Customs (HMRC) (and its predecessor, the Inland Revenue) about deductions for wages in respect of family members (including spouses in some instances) have been the subject of a number of tax cases over the years. These cases have set a precedent for the general proposition that, to be a valid deduction, the following conditions must all be met:
- The amounts must be realistic and not excessive for the work done (e.g. Copeman v William Flood and Sons Ltd  1 KB 202);
- The payments must be recorded in the business records (and PAYE operated as appropriate) (e.g. Abbott v CIR  SSCD 41); and
- The amounts must actually be paid to the spouse for the work done, and not be mere accounting entries (e.g. Moschi v Kelly CA 1952, TC 442).
Even if a spouse’s wages satisfies the above criteria, in order to claim a trading deduction for the period of account in question, the amount charged in the accounts must be ‘paid’ (as under ITTOIA 2005, s 37) within nine months from the end of that period, or the deduction is deferred to the period of account in which it was paid (s 36).
A tax deduction for excessive spouse’s wages is not necessarily ‘all or nothing’. The above ‘wholly and exclusively’ rule also provides that a partial deduction is not prohibited for any identifiable part or proportion of the expense which is incurred wholly and exclusively for the purposes of the trade (s 34(2)). HMRC guidance in its Business Income manual (at BIM47105) states that if the facts show that a “definite part or proportion” of the remuneration is not wholly and exclusively laid out or expended for the purposes of the trade, profession, or vocation, that part or proportion should be disallowed.
In Scott & Ingham v Trehearne  9 TC 69, commission on profits of 33.33% paid by a self-employed individual to each of his two sons was held to have been excessive on the evidence, and 10% was regarded as paid for services rendered and deductible from business profits.
More recently, in McAdam v Revenue and Customs  UKFTT 838 (TC), following an enquiry into the taxpayer’s tax return for 2013/14 and review of his business records as a self-employed plumbing and heating engineer, HMRC concluded that the deduction claimed for wife’s wages was unreasonable. The taxpayer argued that a salary of £90 per week for his wife was not excessive for the duties she carried out “…to maintain the administrative and accounting functions and these duties extend, and are not restricted to, taking telephone enquiries, processing orders and checking part prices”. HMRC accepted that the taxpayer’s wife had done some work, but calculated that an appropriate wage would be £1,344 per annum, at an hourly rate of £8.
The First-tier Tribunal pointed out that it had been furnished with no credible evidence by the taxpayer to support even the wife’s level of working activities that HMRC was prepared to accept, let alone the “nine or ten hours per week” claimed by the taxpayer. The taxpayer’s appeal was dismissed.
A payment for spouse’s wages that is partly disallowed as a business deduction for the self-employed individual is nevertheless likely to remain fully taxable income of the recipient.
Alternatively, even if fully deductible, in some cases HMRC may argue that the wages are taxable income of the worker’s spouse instead, such as under the ‘settlements’ anti-avoidance rules (or, for companies, as remuneration of a controlling director rather than their spouse) (see BIM47106).
In addition to the above criteria for a valid claim for spouse’s wages, evidence of the work done by the spouse and the time spent performing that work should be retained, and their rate of pay should be no higher than a commercial level.
The above article was first published in Business Tax Insider (July 2017) (www.taxinsider.co.uk).