Why would you want to involve your spouse in your SME? Recent ABS data shows that the divorce rate is edging upwards and 40% of marriages are likely to end in the Family Court. And a thriving family business may form an embattled couple’s most valuable asset.
A separated spouse may base a claim for a larger share of the family business assets on his or her involvement in the enterprise. Indeed, the spouses could squabble over who keeps the business in the event of a marriage breakdown.
Even in successful marriages, the risk of family disagreements over the direction of a business will inevitably rise following the employment of a principal’s spouse.
Furthermore, the appointment of a spouse as a director of a family SME can throw a couple’s careful asset-protection planning into disarray, making the private assets of each spouse vulnerable to business creditors in certain circumstances. For instance, ownership of the family home could be placed in jeopardy.
Yet despite the possible negatives arising from employing both spouses in a family business, the current Australian Family & Private Business Survey, reports that more than 35% of family members employed by family businesses are spouses. More spouses are employed in family businesses than any other type of relative.
This survey, conducted by RMIT University for chartered accountants and business consultants MGI, involved 5000 family businesses with turnovers of $2 million-plus.
Sue Prestney, a principal and family business specialist with MGI Melbourne, suspects that the percentage of spouses involved in micro family businesses is even larger.
“It would be unusual with a small business for a spouse not to have some level of involvement even if they have their own day jobs,” says Prestney. “They might just do the books or take calls from customers. It is very hard for a spouse to be excluded from a small business.”
In spite of the potential drawbacks of spouse involvement in your SME, there are definite positives, including the ability to boost tax-effective family income and to increase family superannuation savings in a perhaps unexpected way.
And it is difficult to underestimate the benefit of having someone else involved in your business with a powerful interest in its success.
Here are seven points to consider when thinking about involving your spouse in your business – whether as a full-time or part-time employee or as a director:
1. Family super savings
Your family business can claim tax deductions for extremely large salary-sacrificed contributions to a spouse employee who may only do minimal part-time work – perhaps answering the phone on occasions and doing a little filing.
The Tax Office accepts that these super contributions can be “considerably in excess of the value of the services provided” by the employee without being caught under the Tax Act’s anti-avoidance provisions except in “unusual circumstances”.
This provides an excellent opportunity for a family to boost its overall superannuation savings while at the same time reducing the family business’ tax obligations. Significantly, salary-sacrificed contributions within the concessional contributions cap are taxed at just 15% upon entering a super fund rather than at marginal tax rates.
And the making of extra-large, salary-sacrificed super contributions for a spouse employee may enable a couple to minimise the impact from the imminent halving of the standard concessional contributions cap for members over 50.
By having both spouses employed by the family business – although the possibly previously unemployed person may only do a little part-time work – a couple gains access to two concessional contribution caps.
But be warned, the making of extra-large super contributions that exceed the value of the work performed by a spouse generally may not be effective if a business is caught under the alienation-of-personal-services-income rules.
Broadly, these tax rules may apply to certain small businesses – whether operated through a company, trust, partnership or in the proprietor’s own name – with incomes that are dependent on the skills of a single person and which receive much of their income from a single client. The level of control exercised by a ‘client’ is also taken into account.
In other words, the Tax Office applies the rules to determine whether a business is really being operated or just an arrangement to cut tax by acting as a consultant or contractor.
Small businesses caught under the alienation-of-personal-services-income rules face tight restrictions on their ability to claim deductions – including salary-sacrificed super contributions on behalf of the principal’s spouse.
2. Tax-effective family income
The employment of both spouses could, of course, increase a family’s tax-effective income. For instance, each spouse will have a tax-free threshold of $18,200 from 2012-13 (triple the current threshold) and the benefits of the marginal tax system.
3. Excessive income
Under tax law, income paid to the spouse, or any other family member for that matter, should reflect market rates. In other words, don’t pay your spouse $150,000 a year in salary for answering a few phone calls.
Prestney says excessive payments by a private company to a shareholder or an associate of a shareholder (including a spouse) are not deductible and are deemed as taxable dividends under Section 109 of the Tax Act.
4. Spouse directorships
Think carefully before appointing a spouse as a director or allowing a spouse to perform the duties of a director (even if not formally appointed). The existence of a spouse directorship could damage your family’s finances if your business later gets into financial difficulties.
Under the Corporations Act, a director can be held personally liable for debts incurred while a company is insolvent.
Crucially for spouse directors, the Corporations Act does not distinguish between executive and non-executive directors or between active and in-active directors. And even if a spouse hasn’t been formally appointed a director yet performs the duties of a director, he or she can still be held personally liable for company debts in certain circumstances.
And Prestney warns that a spouse director can be held personally responsible for debts incurred while a company is insolvent even if he or she is a director in name only and in reality makes no decisions as a director.
Furthermore, Prestney points out that a director can be held personally liable for a company’s tax debts including pay as you go (PAYG) instalments as well as superannuation guarantee liabilities.
Another consideration is that many company directors and principals of unincorporated businesses provide personal guarantees for their business’ debts.
5. Family asset protection
In one way, employing a spouse can potentially enable a family to protect more of its assets from creditors if salary-sacrificed super contributions are made on the spouse’s behalf. This is because even large contributions to super are inaccessible to a bankruptcy trustee provided the amounts were not contributed to avoid existing or future creditors.
However, as already discussed (above in point four), a spouse director may be held personally liable for debts incurred while a company was insolvent.
A popular asset-protection strategy, says Prestney, is to place such assets as the family home in the name of the spouse who is least exposed to claims by creditors. “By all means, you can get as much as possible into super but you can’t get your house into super,” she says.
“A couple [where both are directors and thus exposed to business creditors in certain circumstances] could put their home in a family trust,” Prestney adds, “but the home would lose its exemption from land tax and capital gains tax [CGT].”
Prestney says that although the loss of the CGT exemption “is a pretty big downside”, some small business couples may feel it’s worth it to protect their homes.
Some business couples heavily gear their homes, which may reduce the amount recoverable by a future bankruptcy trustee. The money that may have otherwise been spent paying off a home loan could have been contributed to superannuation.
“You need to make sure it’s really worth having your spouse involved in your business [as a director] and having your assets exposed,” Prestney emphasises.
6. Definition of roles
Prestney says a spouse’s involvement in a family business is more likely to become troublesome if no formal agreement – ideally in writing – has been reached about that person’s role. These problems can affect the smooth-running of the business and a couple’s private life.
“When we prepare constitutions for family businesses, we make sure all members of the family have a job description,” Prestney says. “In this way, they know what they are supposed to do and who they are accountable to.”
Prestney says that a family constitution can, for instance, clearly stipulate the role of a spouse who is both a shareholder and a director with minimum management participation. And, she adds, spouse shareholders who are neither directors nor members of management are often satisfied if they are kept informed about the business’s activities.
7. Marriage breakdown
The possibility that a married or de facto relationship could fail should never be overlooked when considering whether to include a spouse in a family business.
An ABS report, Marriages and Divorces, Australia 2010 – published late last year – reports that 50,240 couples divorced in that year, a rise of 1.6% over the previous year. And, of course, these figures do not include de facto couples.
Some married couples confront the possibility of divorce by entering binding financial agreements which set out how assets, including the family business, will be divided if their marriage fails in the future.