Tax Helpsheets
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In this helpsheet we're going to look at the main ways of tax planning with the use of family members...
Paying wages to your spouse/civil partner and children through your business
Your spouse/civil partner may not have any income at all, and almost certainly your children don't. This means their personal allowance is being wasted every year. Even children are entitled to a personal allowance.
If the amount at the level at which income tax becomes payable of £12,570 was paid to them as a wage, they would pay no tax on it and your business profits could be reduced.
Please note that children under the minimum school leaving age can only work a limited number of hours per week and local by-laws may restrict them further
STOP! It is not quite that simple. To pay wages like this you need to follow the following rules...
- It must be for work actually done. Now it is going to be tough to argue your two-year-old son is working for you but many spouses/civil partners do work and mature children may also help out. May be they do the books, answer the phone, stuff envelopes, etc. Keeping out of your way so you can get on does not count, as valuable as it may be. Draw up a list of their responsibilities to help your case. At present they do it for free because it is a family business but they can be paid for it. If you make your spouse a director, all the responsibilities imposed by Company Law on taking on this role must be worth something.
You can also pay a family member a wage where you have property that you rent out and the individual manages the properties.
It is reasonable to pay them a salary commensurate with what they actually do. How much would it cost to get someone in to do that job? The national minimum wage level is at least a good place to start but a higher wage can be paid if you can justify it. - The amount must actually be paid. It is no good the accountant just putting it through the accounts at the end of the year. Pay it, ideally through the bank rather than cash so that it is easy to prove it is been paid and record it in your accounting records.
- Comply with any PAYE procedures as you would do for normal staff. It may also help keep up their National Insurance contribution record even if they don’t pay any National Insurance on the salary.
Making your spouse/civil partner a partner or shareholder in your business to reduce your tax bill
The Arctic Systems case, formally known as Jones v Garnett, was a landmark UK tax case decided by the House of Lords in 2007. It revolved around the use of a family company for tax-efficient income distribution.
The basic idea is that income that is created by your efforts in the business is paid to your spouse/civil partner who pays lower rates of tax than you do, thus saving tax and NI for the whole family.
For example, for 2025/26 if your self-employed business had profits of £80,000, then £50,270 is taxed at basic rates but the remaining £29,730 of this is taxed at 40%, plus 2% NI. So by introducing your spouse/civil partner into the business they can pay basic rate tax on profits that would otherwise be taxed at higher rates.
As with many things in the tax world, it's not always that simple. The major obstacle the Revenue had been trying to put in the way is what is known as the "settlements legislation".
In a nutshell this says if you give something to your spouse that is not wholly or substantially a right to income (meaning that the subject of the gift has a capital value as well as an income producing element), any income that does arise will be treated as the spouse's income for tax purposes.
The law following the Arctic Systems case is that if you give your wife some ordinary shares in your company or perhaps a share in your partnership, this is not just a right to income but it also contains capital rights, as by owning the share they become entitled to a proportion of the assets when the business is closed down and have voting rights . Therefore, the share is not just a right to income.
The actual facts of this case that was finally won by the taxpayer at the House of Lords and cannot now be appealed are as follows...
Mr Jones set up Arctic Systems in 1992 through which to offer his services as an IT contractor. He was the only director and held one of the two ordinary shares issued by the company. Mrs Jones purchased the other ordinary share from the company formation agents, and also became the company secretary.
They acted on advice from their accountant to take minimal salaries from the company, and paid out most of excess profits as dividends. As Mr and Mrs Jones held the shares equally, the dividends were paid to them equally and were mostly covered by their basic rate tax bands, meaning little higher rate tax was paid. If Mr Jones had paid himself a higher salary, or had been the only person receiving a dividend, he would have paid far more tax as much of his income would then have been taxed at the higher tax rate of 40%.
This type of arrangement has been standard tax planning for many husband and wife companies since the introduction of independent taxation for spouses in 1990. However, HMRC decided to attack the arrangement, saying Mrs Jones only received her share, and the dividends paid on that share, because of Mr Jones’ work and the decisions he took as a director. The argument was that Mr Jones had effectively made a gift of half the earning capacity of the company to Mrs Jones, and because she is his spouse, the tax law says he automatically benefits from the gift, and thus Mr Jones should be taxed on all of the dividends.
The House of Lords agreed with HMRC that the shareholdings in the company had been set up to minimise the tax paid by Mr and Mrs Jones. However, because the gift by Mr Jones had been made to his wife, and the gift was not restricted to the earning capacity of the company, but included future rights to capital on liquidation, and the voting rights associated with the ordinary share, there was a get-out clause. This get-out clause only applies to married couples and civil partnerships, and says that if you make a gift to your spouse/civil partner (which comprises more than just income), and there are no strings attached, you should not be taxed on the income arising from that gift.
Mr Jones had allowed Mrs Jones to buy half of the company (the other ordinary share) for a very small sum. This did amount to a gift, but the gift was covered by what is known as the "spouse exemption", so Mr Jones could not be taxed on the dividends arising from Mrs Jones' share.
Income Shifting
The day after the House of Lords judgement the Treasury minister under the previous Government said they would act against couples who indulge in income splitting in an unfair way.
The description of this unacceptable behaviour was given as ‘income shifting’, defined as where one person diverts their income to a second person who is subject to tax at a lower rate, to obtain a tax advantage.
In the 2008 Budget, the government announced new legislation targeting ‘income shifting’ but it faced criticism for its complexity and potential impact on small businesses. As a result, the government decided to delay it, and ultimately, the income-shifting rules were never enacted.
The settlements legislation, as clarified by the Arctic Systems case, remains in place, with the spousal exemption still applicable under specific conditions.
Family tax planning for business Overview
Utilising Personal Allowances:
Each family member can earn up to £12,570 tax-free in 2025/26. Paying wages within this limit ensures no income tax liability, reducing the overall tax burden for your household.
Employing Family Members:
You can legally employ family members, such as your spouse, civil partner, or children, in your business. Their roles must involve genuine, necessary work, and tasks should be appropriate to their skills and qualifications.
Examples of Genuine Work:
- Administrative Tasks: Managing emails, handling bookkeeping, or scheduling.
- Marketing & Social Media: Creating posts, running campaigns, or engaging with customers online
- Professional/Skilled Work: Tasks like website design, conducting research, or helping with production (if trained).
- Manual/Operational Roles: Packing orders, managing inventory, or providing customer service.
- Age-Appropriate Roles for Children: Filing, data entry, or assisting with small operational duties.
Reasonable Pay:
Pay family members a salary that reflects the market rate for the work they perform. Excessive or symbolic payments could attract scrutiny from HMRC.
Proper Documentation:
Maintain employment contracts, job descriptions, timesheets, and evidence of work completed to demonstrate compliance.
PAYE Compliance:
Process wages through PAYE (Pay As You Earn), deducting the appropriate tax and National Insurance contributions.
National Minimum Wage:
Pay at least the National Minimum Wage (or National Living Wage, if applicable) for the hours worked, unless exemptions apply (e.g., for children under 16).
Pension Contributions:
Make employer pension contributions for family members, which are both tax-deductible for the business and a valuable long-term benefit for them.
Avoid Artificial Arrangements:
Ensure family members genuinely contribute to the business and avoid creating arrangements solely to reduce tax liabilities. HMRC monitors for practices that appear artificial or unreasonable.
How We Can Help You
Family tax planning, especially when trying to share the profits of a business is very complex and we can advise you on the best strategy in your own circumstances.