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HMRC internal manual

Business Income Manual

Specific deductions: staffing costs: remuneration payments to friends and relatives: wholly and exclusively

S34(1) Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005), S54(1) Corporation Tax Act 2009

Controlling directors

Controlling directors are often the driving force behind a company. Where the controlling director is also the person whose work generates the company’s income then the level of the remuneration package is a commercial decision and it is unlikely that there will be a non-trade purpose for the level of the remuneration package. It should be noted that remuneration does not include entitlement to dividends etc arising in the capacity of shareholder.

Other employees

Where the remuneration package paid in respect of other directors (or an employee who is a close relative or friend of the business proprietor or controlling director) is in line with that paid to unconnected employees, you should accept that the package is paid wholly and exclusively for the purposes of the trade.

However precise comparisons are not always possible. Careful consideration of the facts will be required in worthwhile cases to establish whether the level of the remuneration paid to a friend or relative of the proprietor is commercial and commensurate with the duties undertaken. The chosen comparators need to have similar qualifications, experience and job description.

It may be helpful to consider variations in the level of remuneration over time; however it is important to establish the reasons for such variations, which may include an element of catch up. One element of the remuneration package where this may apply is with regard to employer contributions to the employee’s pension (BIM46035).

If the amounts involved and the facts established indicate that a remuneration package is demonstrably in excess of what is commercially reasonable, then there may be other avenues to consider in addition to the question of whether an element of the payment is other than wholly or exclusively for the purposes of the trade. In particular it may also be appropriate to consider whether the settlements legislation might apply or if payment is in fact part of the controlling director’s remuneration or the proprietor’s drawings rather than market rate remuneration of the relative/friend employee (see below).

Settlements legislation

Where remuneration that cannot be justified on ordinary commercial grounds is paid to a director/employee who is the husband, wife or minor child of the controlling shareholder(s) or director(s), liability to tax may also arise under the settlements legislation in Part 5 Ch 5 ITTOIA 2005, see TSEM4000 onwards. Advice should be obtained from HMRC Trusts and Estates on the facts of each case before considering whether liability arises under Chapter 5.

Whose remuneration package?

If a payment or part of a payment to a relative or close friend of a director appears not to form part of their remuneration, to the extent that it appears to exceed what is reasonably commercial, then it may actually be part of the director’s own remuneration. So although the payment may be wholly and exclusively for the purposes of the trade, it will in the following circumstances be taxable in the hands of the director rather than the employee if:

  • the spouse or close relative is simply acting as a conduit for the director, then the payment may be taxable as earnings of the director (S62 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)), or
  • the payment is made to a relative or a member of the director’s family or household (S201(5), S721(5) ITEPA 2003, see EIM20504) then it may be taxable on the director under the benefits legislation.

For further guidance on these points contact IPD Employment Income, Technical