Contractors’ Questions: Does dividend-low salary mix breach minimum wage rules?

Contractor’s Question: As a director of a limited company, which I’m thinking of setting up, I understand that, for tax and legal purposes, I would be classed as an employee of the company. But I’m put off from incorporating because I’ve heard that if I was to pay myself less than the minimum wage for the hours I worked, that I, or specifically the company, would be in breach of the national minimum wage act. This could land me with a fine and a criminal record.

This seems a strange predicament for a new business to have to face, given that trading as a one-person company and drawing only a small salary has become standard practice for many contractors. Confusing me even more are suggestions that NMW rules only apply if you have a contract (written or implied) of employment with the company, and that such a contract needs to exist if you want to claim working tax credit. Surely minimum wage rules weren’t designed to trap owner-managers in the ways I have described? Is it hopefully the case that any enforcement of NMW rules on one-person limited companies is therefore light-touch, or at least left to the discretion of the enforcement official?

Expert’s Answer: Firstly The National Minimum Wage Act applies only to "workers" as defined under the National Minimum Wage Act 1998 s.1(2)). A company director is therefore covered by the act only if he counts as a "worker" within the definition in National Minimum Wage Act 1998 (s.54). The position of "company director" is an "office" not an employment. A director may be an employee as well as being a director but this is not automatic.

So a non–executive director falls out with the scope of the act. However it appears that this straightforward answer will not settle all your curiosities.

If your Limited Company has registered for PAYE purposes, and you are withdrawing a salary (or mix of salary and dividends) then you could be considered as a “worker”. In theory you should then be drawing salary equivalent to NMW. However, you also must consider the success of your business and the cashflow - there simply may not be enough money available to do so.

What is the reality of the situation? If a director cannot pay himself the NMW, or chooses not to, will they be prosecuted until they do? Or will they be forced to close their company? The answer, in our opinion, is of course not. But legal advice should always be sought if there is any doubt by someone in the director- as-employee position.  

NMW was introduced to protect employees, and in our experience disputes regarding NMW are brought to the attention of the authorities by employees whose employers are breaking the law by paying less than the act stipulates (currently £5.93 per hour for those aged 21 or over, set to rise to £6.08 on 1^st October 2011). Are you, as an employee of your Limited Company, likely to bring this to the attention of HM Revenue & Customs?

If HMRC were to investigate your limited company and found that you were not complying with the NMH Act then an enforcement notice could be issued. The employee would be entitled to the arrears of wages at the current rates, and the employer could face a penalty set at 50% of the underpayment, ranging from a minimum of £100 to a maximum £5,000.

The expert was Alasdair McGill, managing director of tax and accountancy specialists Freelance World.