Lines will always be blurred in family businesses. Over time family members will often find themselves with multiple roles and it makes the matter of fair payment a very slippery idea. That’s especially true if you’re trying to work out what to pay yourself.
As a principle, the level of remuneration should reflect the roles played by family members. However, in my experience it is rare to see a separate fee paid to family members who act as a director in addition to being an employee. And because the responsibilities of a director are quite onerous, this can cause problems.
Unfortunately a truly commercial salary is rarely paid in a typical mum and dad family business. There can be many reasons for this, some of which may be rooted in history. That is, mum and dad started the business and so far it’s only been in the growth phase, which means cash has always been reinvested back in the business. In these cases the business owners usually only draws a salary sufficient to live on.
What’s a competitive salary?
Figuring out what is the market rate for family members working in the business is part art and part science -- meaning that you’ll never have 100 per cent accuracy.
In my view, business owners should use the same methodology that they use to assess salaries paid to non-family members. Develop a job description for the role and research the market for similar roles. See if you can settle upon a salary range. In most industries yearly salary surveys are conducted by the main recruitment firms and these are usually readily available through a Google search or by contacting recruitment firms directly. Most firms are happy to provide these free of charge in the hope of getting business.
When the money starts to increase so can your salary, but tread carefully -- it’s important for you to able to justify it to other family members. Obviously if you are paying yourself at the top end of that salary range then you potentially leave yourself open to suggestions that you may be overpaying yourself, but you should feel pretty safe if you are in the middle of the band.
When tax changes the equation
Tax can often be a reason for salaries not to reflect the industry standard.
Specifically, the business might be operating through a company structure, paying 30 per cent tax. That means a salary of $200,000, while commercially realistic, will result in a large portion of it being taxed at a higher rate than the 30 per cent company rate -- possibly as high at 46.5 per cent.
So the business owner often elects to leave that income in the company and pay tax at 30 per cent.
But eventually that money will end up coming out of the company. When it does, it may be drip-fed out over many years, perhaps when the business owner has retired and has little other income (other than a tax exempt super fund pension). The result could be that the franking credits on the dividend (for the 30 per cent tax paid in the company) more than cover any tax payable by the owner, even potentially resulting in a refund of tax.
There is also the issue of superannuation contributions impacting on salary -- particularly so when the deductible super contribution limits were much higher. It was not uncommon for business owners to maximise contributions into super at the expense of lower salaries. However, the whole package (salary, super and other fringe benefits including cars) needs to be considered.
If and when it comes time to sell
In my experience, potential purchasers start to get nervous when more and more adjustments are made to the financials, particularly to make them look better. Vendors will often look to make notional ‘adjustments’ to prior year profit results to remove some transactions. Adjustments to the level of owners’ salaries are not uncommon.
My tip would be that if you are planning to sell your business in the next three years or so then start removing all these non arm’s-length transactions from your accounts.
It’s important to keep any emotion out of family business pay slips. Make sure you know what the market rate is for all the positions in your business and maintain ongoing performance assessments to determine whether each employee, family and non-family, is earning their keep.
Grant Field is chairman of MGI Australasia and specialises in family business advising