The tax traps of employing family members

Employing a family member in a business, or in an activity that generates taxable income (like owning a rental property), is not uncommon. But there’s a right way and a wrong way to go about it.

Owning a rental property brings with it all sorts of obligations, and tax is one of them. Owners of rental properties have been on notice for some time that the Tax Office is concerned about incorrect reporting of income and the incorrect claiming of tax deductions. So the warnings are out there.

A recent decision of the Administrative Appeals Tribunal (AAT) provides a warning about involving and employing family members in rental properties.

In that case, the taxpayer (a Mr Brown) owned a rental property. The property was available for rent throughout the time it was in Mr Brown’s hands, although there were periods when it was untenanted.

During the year in question, the property was managed by a local real estate agent who collected the rent and dealt with the tenants. If there were maintenance requests or any other issues, Mr and Mrs Brown both said the agent would call the Brown residence where Mrs Brown would typically deal with the matter.

Mr Brown decided to pay his wife for her work related to the property – paperwork, collecting mail and the like. He paid her $25,000 in wages and allowances and also made contributions into his wife’s superannuation of $35,000. He claimed tax deductions for these payments which the Tax Commissioner disallowed.

The relevant provisions in the tax law permit a taxpayer to claim deductions in respect of losses or outgoings incurred in gaining or producing assessable income. Deductions are not allowable for expenses of a private or domestic nature. The Tax Commissioner claimed Mr Brown’s payments to his wife were of a private or domestic nature.

The Tribunal said it was not persuaded that the taxpayer attempted, nor was motivated, to enter into a genuine employment relationship with his wife, nor that the money was paid to meet a business expense, as opposed to a domestic or private expense. The Tribunal noted that the wife’s “job” was not clearly defined. It also noted that she provided unpaid assistance at another family business, which was not mentioned in the taxpayer’s submission of evidence.

The Tribunal said the taxpayer’s evidence was “inconsistent” with the evidence of his wife and of his tax agent, whose accounts were “more consistent” with each other. The Tribunal said it was not persuaded by the taxpayer’s evidence – it said it was not clear he did anything but talk about employing his wife in order to achieve a tax advantage that would otherwise be unavailable to him.

The Tribunal said the taxpayer had not discharged his obligation of proving that the Commissioner’s tax assessment was excessive. The AAT also upheld a penalty of 25% imposed on the taxpayer by the Commissioner for not exercising reasonable care.

It is not illegal to employee one’s spourse, but the employment relationship must be demonstrable and clearly defined. The AAT in the case above was not satisfied this had been done.  

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .

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