Contractor Doctor: Do I need an employment contract with my limited company?

Dear Contractor Doctor,

I’m an IT contractor and have been trading as a limited company contractor for nine years.

I have never had an employment contract with my own company, but recently, one of the other contractors I’ve been working with has said if I don’t have one I’ll lose out on all sorts of employment legislation protection.

Do I need an employment contract with my contractor limited company?

Thanks

Travis

Contractor Doctor says:

There are advantages and disadvantages for contractors who have an employment contract in place. Lawspeed’s head of employment law Theresa Mimnagh and Abbott Moore’s owner and head of tax James Abbott explain the options available and their implications.

Limited company contractors who are directors of their business don’t need to have an employment contract in place. But if they do, there are implications and, for contractors intent on developing their contractor business beyond purely contracting, in certain circumstances an employment contract may be beneficial.

What employment law says about employment contracts

According to Mimnagh, whilst employment status is a complex area, if a contractor takes employment income from their contractor limited company then the most likely assumption would be that the contractor is an employee of the company. In which case, employment law says an employment contract is required.

“It is technically illegal for workers to receive employment income without an employment contract,” she says.

But, as Mimnagh points out: “This can be a claim which is made in an employment tribunal, by an individual who has not received such a contract. A contractor who is a director and shareholder in their business is not going to make a claim to an employment tribunal against their own business.”

On very rare occasions, a client might require the contractor’s limited company to employ all those who provide services on behalf of the business, but this would be unusual.

The tax and financial implications

If a contractor does have an employment contract with their contractor limited company they could incur additional income tax and National Insurance Contributions (NICs). Abbot explains: “When a director of a company has an employment contract, they lose the right to national minimum wage (NMW) exemption.

“So,” he continues, “if the contractor is over twenty-one, the national minimum wage from 1 October 2011 is £6.08. Assuming a 40-hour week, this works out to be an annual salary of £12,600. Most limited company contractors pay a salary only up to the national insurance threshold, which is considerably less, and take additional money from the business in the form of dividends paid from the profits.”

Contractor’s limited companies will qualify for a corporation tax deduction for any salary paid, but even taking this into account, Abbott says that contractors could be out of pocket to the tune of £1,170 each year. “For a contractor on £350 per day, this is not far short of a week’s work,” adds Abbott.

What’s more, Abbott confirms that there are no state pension or national insurance advantages to be gained by having an employment contract and adhering to national minimum wage requirements.

When business building, an employment contract can be advantageous

Although most limited company contractors who are focused purely on building and running a one-person contracting business won’t benefit much from having an employment contract in place, Mimnagh says it might be different for contractors with greater ambitions.

“If a contractor has created intellectual property assets in their business or has ambitions to take on employees and grow their business, then it might be advantageous to have an employment contract in place.”

Where there is the chance of a contractor ceasing to be the principal in the business and losing control, then an employment contract could also be of benefit.

Good luck with your contracting!

Contractor Doctor