HMRC disapproves of director shareholders paying their spouses a salary from the business solely to reduce tax. It considers such arrangements unfair avoidance. Is there an alternative which won’t cause problems with HMRC?

Reducing tax by income shifting

As a director you’ll know from personal experience that the government has for some time been reducing the rate of tax on company profits while increasing it on directors when they draw money as, say, salary or dividends. A tactic used by many directors to reduce their tax and NI bill is to redirect some of their pay to their spouse or partner if they pay tax at a lower rate.

Example. Tim is a director of Acom Ltd. He takes a salary of £30,000 per year plus a larger amount in dividends, so he pays tax at the higher rate. His fiancée, Jan, works part time and earns £8,000 per year on which she pays no tax or NI. Tim reduces his salary by £5,000, which is paid to Jan instead. As a result Tim’s tax and NI reduces by £2,225. Acom also saves NI contributions of £690. Jan pays tax on the £5,000 salary of £400, but not NI. The net saving is £2,

HMRC’s view

HMRC has no problem with Tim’s arrangement as long as Jan works for Acom and the work she does justifies the £5,000 salary. If it doesn’t HMRC can legitimately refuse Acom a tax deduction for Jan and could even cancel the tax saving made by Tim. That would make Acom, Jan and Tim worse off than had he left things alone.

Made up job

Tim could create a job that Jan can do at home, say, compiling statistics, record keeping, research or just putting documents in envelopes. It doesn’t matter to HMRC that Tim created the job, only that it exists and Jan does the work.

Tip. As an alternative to finding or creating regular work for your spouse or partner you could invite them to join the board of directors in a non-working (non-executive) capacity. You can compensate them for the duties and responsibilities under company law by paying directors’ fees.

A non-executive director (NED)

Being a NED doesn’t mean they can do nothing and get paid, but in practice their role can be limited to attending board meetings and occasionally signing a document. If you’re the only other director the board meeting could even be held at home or in a restaurant. Alternatively, they could attend by conference call or online.

What’s a NED worth?

It’s not easy for HMRC to attack the level of directors’ fees paid in the same way that it can the rate of pay for a job. There are broad benchmarks published that indicate the amount of directors’ fees that are typical for NEDs of large corporations. While these can run into tens of thousands, that level of fee isn’t usually appropriate for small to medium-sized businesses.

Rule of thumb. For most small companies a director’s fee of up to £3,000 per annum would probably not cause trouble with HMRC. But in case it asks questions about the NED’s role make sure you keep a record of the board meetings etc. they attend to demonstrate that they have played a role in directing your company.

You can appoint your spouse or partner as a director of your company in a non-working capacity and pay them director’s fees to compensate them. They do not need to work in the business to justify these. However, whenever possible, they should attend board meetings and play a part in decision making.