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Following on from an earlier article "Are you an employee of your own limited company?" this article looks at the effect on the director of a company as to whether they are an employee or an office-holder. For the purposes of tax and employment legislation it is necessary to be able to distinguish between a director as an office-holder and that director as an employee. An individual who holds the office of director is not necessarily an 'employee' even though they may be the only person working in the company. It is necessary to establish the status because of the possible effects it may have on issues such as redundancy, dismissal, insurance, and the national minimum wage. Grounds to Consider In two recent cases there has been a difference of opinion as to whether a director is also capable of being an employee. In Buchan & Ivey v. Secretary of State for Trade and Industry [1997] EAT it was stated that a 'controlling' shareholder could not be an employee of his company. Whereas in Fleming v. Secretary of State for Trade and Industry [1997] EAT it was stated that Mr Fleming, as a controlling shareholder, could be an employee. The question came up for review again in the Secretary of State for Trade and Industry v. Bottrill [1999] EWCA Case No. 980132. It was decided in that case that Mr Bottrill was an employee of his limited company despite the fact that he was the Managing Director and a sole shareholder at the material time. In a further case, Farleigh v. Secretary of State for Trade and Industry [2000] EAT it was decided that the sole director and shareholder could not be an employee of his own limited company for the purposes of a redundancy payment from the National Insurance Fund. The EAT, in upholding the decision of the tribunal, found that from 1997 onwards when Mr Farleigh became sole shareholder he was not then an employee of the company. The reasons stated were that: (a) there was no-one in the company to whom Mr Farleigh was answerable; (b) there was no-one who could dismiss him; (c) there was no-one to control his actions; (d) he was in effect the sole proprietor of this business; and it was he who dismissed the employees when the company went into liquidation. In considering the facts, the tribunal accepted that a controlling shareholder can be an employee but that in this case when the relevant factors were weighed it was decided that Mr Farleigh was not. In addition to the change in share ownership and the heavy investment which was made in the company which involved personal guarantees, there was also no contract of employment in writing, no evidence of an express or oral agreement, and no board minutes or written memorandum. The terms of the legal relationship between the Company and Mr Farleigh were not one of employer/employee and the control of the company by Mr Farleigh was genuine. In the most recent case of Connolly v. Sellers Arenascene Ltd1 which was decided in the Court of Appeal on 2 February 2001, the Court followed the guidance of Lord Woolf in Bottrill. In practical terms it would appear, for the time being at least, that when deciding on the status of a director it would be wise to follow Bottrill2. Guidance Lord Woolf MR in Bottrill gave some guidance in this case on how to decide on the status of a controlling or sole shareholder. It was stressed, however, that they were not rigid guidelines for the factual inquiry by the tribunal because each case must be decided on the particular circumstances. The questions which the tribunal might wish to consider are these:
In practical terms, what difference does it make if an individual as a director is found not to be an employee of his own limited company? Emoluments The remuneration received by the individual as a director and the individual as an employee are governed by the same tax regulations Schedule E of the Income and Corporations Taxes Act 1988. Tax under this Schedule is charged on emoluments in respect of any 'office' or 'employment'. The difference that this makes is whether the director takes emoluments in the form of fees, percentages, expenses and benefits in kind as the holder of the office of director or, whether the director draws a salary or wage for their employment by the company. A distinction has been made between 'wages' and 'emoluments'. The Inland Revenue in Tax Bulletin Issue 24 in August 1996, stated that what constitutes wages under employment law is not the same as what constitutes emoluments under tax law and this is shown in the case EMI Group Electronics Limited v. Coldicott (HMIT) 1999 EWCA 3210. For practical purposes the difference that this makes in tax law is very little but in employment law it could be crucial. When establishing the status of the director, the type of remuneration recorded in the company accounts will be evidence of whether the director is also an employee. If the company accounts show the entry for remuneration as 'fees and emoluments' rather than 'wages' it may be evidence that the director is not also an employee. Expenses In the case of expenses if a director of a company decided to move the business, which also happens to involve a change of residence, it would be easier to establish that the expenses incurred were 'wholly and exclusively ' for business purposes. Whereas, if an employee has to relocate because of work, the expenses incurred are unlikely to be deductible (MacKinlay v. Arthur Young McCleland Moores & Co [1990] 2 AC 239 HL). National Minimum Wage All workers are entitled to the National Minimum Wage (NMW)which is a legal obligation. The legislation enforces this on all employers so, an individual cannot choose not to receive payment. The situation is different, however, if you are a director. As long as the director does not have an explicit contract of employment with the company, the director is not subject to the NMW legislation. This has now been confirmed by the DTI although it has not as yet been tested by the courts. Insurance In the precedent case Lee v. Lee's Air Farming Ltd [1961] AC 12 PC Mr Lee was sole shareholder and sole governing director of the company. He was also appointed chief pilot. In accordance with the company's statutory obligations the company insured against liability to pay compensation under the Workmen's Compensation Act. Mr Lee was killed in an accident and his widow claimed compensation under the insurance. The Court of Appeal, however, ruled that Mr Lee could not be regarded as a 'worker' within the meaning of the Act and his widow could not therefore claim compensation. The Privy Council reversed the decision of the Court of Appeal and held that Mr Lee as director of the company, could enter into contractual relations under which Mr Lee as chief pilot could benefit. Redundancy The Employment Rights Act 1996, makes provision for a redundancy payment where the 'employer', being a company, goes insolvent. In this situation under s.166, the employee can apply to the Secretary of State for a statutory redundancy payment to be made out of the National Insurance Fund. The criteria, however, is that the individual is an 'employee'. The cases of Buchan, Fleming, Bottrill and Farleigh were all based on an application for a statutory redundancy payment. In these cases, mentioned above, the court was asked to decide whether the applicant, as a director of the company, was also an employee of the same. As can be seen from these cases, there is no rule of law but, it would appear that there is some semblance of a criteria by which a decision can be made. Dismissal In the case of Parsons v. Albert J. Parsons & Sons Ltd [1978] ICR 271 there were four directors of a family company with two wholly owned subsidiaries. Mr Leonard Parsons was removed from the office of director and dismissed by a resolution of the company. He applied to the industrial tribunal for compensation for unfair dismissal describing his position within the company as director. In order for the applicant to succeed under the relevant legislation the court had to decide upon whether he was an 'employee' as well as a director. The facts taken into consideration were that Mr Parsons had:
Loss of Office If the director is unable to claim unfair dismissal he could in the alternative claim compensation for loss of office. The compensation would be taxable as an emolument if the payment was made to the director as part of his remuneration for his services as director. If, however, the payment is made pursuant to an agreement to waive or release an existing obligation entered into at the commencement of the employment it is not taxable as an emolument. Administration of a Sole Member/Director When a private limited company with only one member enters into a contract with that one member and the sole member is also a director the contract must be evidenced in writing. If the contract is not in written form then the company must ensure that the terms are set out either in a written memorandum or are recorded in the minutes of the first meeting of the company following the making of the contract. If this section is not complied with the company shall be liable for a level two fine, currently £500.00. This provision is contained in s.322B of the Companies Act 1985. It is not clear whether this section relates to the contract as one of employment. If it does then this means that every sole director/member of a company shall have a written contract of employment or be liable to a fine. Salomon It appears from case law that it is more prevalent for a director of a 'one-man' limited company to be found not to be an employee than a director of a larger company. This must surely attack the founding principles of company law in the Salomon case. Since this case the maxim that a company has a separate legal entity quite distinct from that of it's members has been set in stone. The recent cases, however, show judicial uncertainty in this area and the decisions leave a sole director vulnerable to claims that his company is a mere 'sham'. 1.As the full judgment of the Court of Appeal is not available on-line it may be of use to read the judgment of the Employment Appeal Tribunal 2.Connolly v. Sellers Arenascene Ltd was covered in an earlier article by the author. |
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