Dear Contractor Doctor,
I am a contractor who has been running my own limited company for several years. I am the only shareholder and director in my company.
My spouse is company secretary and has always kept my invoicing up-to-date and prepared our VAT returns.
Can I pay my spouse a salary?
Contractor Doctor says:
“Yes, you can pay your spouse a salary and should be doing so,” explains James Abbott, owner and head of tax at contractor accountant Abbott Moore LLP. “Spouses and partners working in micro-businesses fulfil a vital role that frees up the fee earner to maximise their income,” continues Abbott, “and the spouse or partner should be drawing a salary for the work that they do.”
Paying a salary also entitles a spouse to benefit from Section 1030A dispersals (formerly ESC C16) and entrepreneur’s relief. But the spouse or partner in question must actually be doing something for the business, and being paid according to their role and hours. They should not be being paid simply as a means of generating costs within the business or using a spouse’s tax allowances.
Inside or outside IR35?
The salary drawn by a spouse is treated differently according to whether the contractor’s current contract is inside or outside IR35, so contractors should be sure of their IR35 status when processing the salary.
“If a contractor is inside IR35 you can still pay a salary to your spouse,” says Abbott, “and it will form part of the 5% overheads allowance when calculating your deemed payment, so the amount you pay will be limited.”
Where the contract is outside IR35, the full salary is a legitimate business expense and wholly deductible against the contractor’s limited company corporation tax.
The settlements legislation is irrelevant when employing a spouse or partner
In the context of a spouse or partner’s salary, the settlements legislation is irrelevant, says Abbott: “Section 624 of the settlements legislation, which was formerly known as Section 660, is a red herring when considering the level of salary to pay a spouse.”
Following the Arctic Systems ruling, spouses and civil partners receiving ordinary shares are exempt from the settlements legislation. They can legitimately receive dividend income without it being taxed as if part of the income of the main fee earner, as would be the case if the settlements legislation applied.
But the spouse or partner may not be a shareholder and must be being paid a legitimate salary in line with the duties they perform for the contractor’s company. This salary is outside the scope of the settlements legislation.
Qualifying for Section 1030A (formerly ESC C16) dispersals and Entrepreneur’s Relief
Using a Section 1030A dispersal or Entrepreneur’s Relief (ER) enables contractors closing their limited companies to distribute cash balances below £25,000 as capital, and benefit from the lower capital gains tax rate.
However, HMRC’s rules state that, unless an individual is a paid employee or limited company office holder, such as a company secretary or director, it is not possible for them to benefit from a Section 1030A dispersal or Entrepreneur’s Relief.
Timing salary payments is crucial when calculating National Insurance Contributions
The timing of salary payments can have a significant impact on the National Insurance Contributions (NICs) a spouse or partner who is not a director may pay. Abbott explains: “If the spouse’s salary is up to the personal allowance limit of £8,105 and paid all in a single month, the first £624 is exempt from NICs, the next £2,916 attracts employees a National Insurance charge of 12% and NICs at 2% are charged on the salary over £3,540.”
Conversely, if the contractor’s spouse or partner is paid monthly, which works out to be £675 per month, only £55 attracts an NIC charge of 12%, because the spouse benefits from the £620 exemption. Similar principles apply to employer’s National Insurance.
“This only applies to salaried employees who are non-directors,” adds Abbott. “Directors account for NIC liabilities on an annual basis.”
Market prices for salary
In addition to actually undertaking work for the business (and having proof of that if the business or contractor becomes the subject of a tax investigation), a contractor’s spouse should only be paid what they are worth for the job they do and hours they work.
This, according to Abbott, is a tough call; what value do you put on someone who is a receptionist, personal assistant, bookkeeper, post room manager, accounts department and company secretary all rolled into one?
“Paying a spouse £100 per hour would be hard to justify to HMRC and may be close to what the contractor themself is earning,” continues Abbott, “The key question is, what would you pay someone who wasn’t your spouse to do the same job?”
Abbott adds that the spouse or partner’s full package must be taken into consideration when considering what is a reasonable level of remuneration. This includes pension contributions and other benefits, such as a company car.
Timesheets and diaries
Because HMRC can investigate and dispute payments made to a spouse up to six years ago, Abbott strongly urges contractors’ spouses and partners to keep a record of the work they do for the business: “Because many spouses multi-task in a business, it is all too easy to lose track of exactly what they have contributed in a given week, and even more difficult when going back six years.”
Keeping a simple diary, and ideally time sheets as if they were a fee-earner, will prove to HMRC that the spouse was legitimately earning their salary. Even better are, for example, mileage expenses claims for those trips to the bank and post office that are required for the spouse to fulfil their ‘office manager’ role.
Good luck with your contracting!