Contractors' Questions: Do I need a contract with my limited company?

Contractor’s Question: Is it a legal requirement, or a requirement from HM Revenue & Customs, for a limited company and the sole director/employee to have a contract of employment between them?

Expert’s Answer: The Companies Act 2006 defines directors as officers of a company and the Employment Rights Act 1996 applies only to employees under a contract of employment, whether express or implied. Therefore, there is no legal requirement for a contract of employment to exist between a limited company and its sole director if the sole director's functions are just to comply with the statutory duties as an officer.

However, a director will be an employee if there is a contract of services with the company whether express or implied, and case law suggests that where the sole director personally performs services for the company in addition to normal statutory duties and receives taxable payment for work done (as opposed to pure director's fees), then a contract of services, i.e. employment, is likely to be implied. The question of whether a director is also an employee depends on the facts of each case.

This is of relevance to limited company contractors who are both the director and sole representative of their company when undertaking assignments via a recruiter or directly with an end-client. The Companies Act 2006 (s228) requires a company to keep a copy of the director's service contract available for inspection. If the service contract is not in writing then a memorandum summarising the key terms must be retained.

There are certain benefits for a sole director to be an employee of the company. In the case of Secretary of State for DBERR v Neufeld [2009], the Court of Appeal decided that, on the facts, a director was also an employee and could claim redundancy payment from the Secretary of State under the Employment Rights Act 1996 (s188) when the director's company became insolvent in the same manner as former Woolworths employees.

In the recent Employee Appeal Tribunal decision in Secretary of State for BIS v Knight [2014], the claimant was found to be entitled to £7,296 in redundancy payment by the Insolvency Service as there was sufficient mutuality of obligations, despite the fact that a salary had not been paid for two years due to adverse trading conditions. An employment tribunal would ascertain whether the contract is genuine and whether the contract is in fact a contract of employment or a contract for services. The two cases referred to were decided on their individual facts and advice must be sought about a particular director's employment status.

If a company employs its director, then HM Revenue & Customs must be notified if any of the criteria listed here apply. This excludes dividends paid by the company to the director.

Your type of question usually arises because end-clients in a recruitment chain want additional protection to guard against employment claims brought by individuals using limited companies. Such concerns are unfounded though because the IR35 legislation does not grant employment rights where a taxpayer is found be inside IR35. The status of the director as far as his/her own company is concerned is irrelevant when assessing whether IR35 should apply.

In conclusion, there is no legal requirement for a contract of employment to exist between a limited company and its sole director and while directors may be an employee of the company if certain tests are met, HMRC would not be concerned with the actual contract. Directors who are employees can claim statutory redundancy payments if their company becomes insolvent.

The expert was Martyn Valentine, founder of The Law Place, a legal advisory specialising in employment status.