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The dividend of the affair

In my last but one article on planning for the family company, I concentrated on the opportunities for (and constraints on) remuneration planning for the spouse and children of business owners.

In that consideration, I mentioned the national minimum wage provisions. In making payments from a business to persons such as children and a spouse who otherwise have no taxable income, then the national minimum wage provisions are not usually relevant. This is because the object of the exercise will often be to pay an amount as remuneration that will be tax-free within the personal allowance.

To do this most tax-effectively, a salary will be necessary. Payment by way of dividend (assuming, of course, that the payee is a shareholder) will give rise to no deduction for the company, dividends being paid out of after-tax income, and no reclaim of the tax credit on the dividend for the payee.

It is where a company wishes to pay a director/shareholder wholly by way of dividend that the national minimum wage provisions need to be considered. In considering this strategy, it would also be worth bearing in mind the loss of National Insurance benefits that would result from paying no National Insurance contributions.

Returning, however, to the national minimum wage, how is this relevant for owner-managers? The relevant legislation is the National Minimum Wage Act 1988 and the National Minimum Wage Regulations which came into force on April 1, 1999.

The provisions apply where the individual has a contract of employment. Interestingly, a director&#39s rights or duties are defined by their office and a director can be removed by simple majority vote. If a director works actively in the business, receives a salary and enjoys the rights usually accorded to employees, then an employer/employee relationship is formed and employee&#39s rights and duties are defined by their contract of employment whether written, oral or implied.

The question for many small or medium-sized enterprises considering or actively adopting an all-dividend policy of director payment is whether a contract of employment exists with the director.

It seems, as you would expect, that the existence or not of such a contract is a question of fact.

It is necessary to ask whether an office-holder, that is, a director, is employed. It seems tolerably clear that, if there is no explicit contract, then there are no national minimum wage requirements even if the director carries out a wide range of activities.

It is understood that the DTI has confirmed that if there is no written employment contract or other evidence of intent to create an employer/employee relationship, then the national minimum wage provisions do not apply.

For reference, the new rates of national minimum wage effective from October 1, 2001 are as follows:

£3.50 an hour for employees aged between 18 and 21 years (£3.20 an hour up to September 30, 2001 and provisionally £3.60 from October 1, 2002).

£4.10 an hour for employees aged 22 years or more (£3.70 an hour up to September 30, 2001 and provisionally £4.20 an hour from October 1, 2002).

In closing, even where it is decided (after consultation with professional advisers) that no national minimum wage is required for a director, say, because an all-dividend policy is to be pursued, the director may still be well advised to pay him or herself the minimum (£72 a week for 2001/02) to become entitled to National Insurance benefits and to avoid relying on avoiding the national minimum wage provisions through reliance on the fact of there being no contract of employment in the particular case under consideration.

Indeed, in the light of the opportunities for planning under the new defined-contribution tax regime, a director may choose for at least one year to take substantial earnings which, once certified, can form the basis of the defined-contribution tax regime contributions for the next five tax years, even if, in those five tax years, drawings are taken substantially (or even totally) in the form of dividends.

This can mean that relatively high levels of pension contributions can be paid even when actual earnings for the year of payment are quite low, so allowing high levels of defined-contribution tax regime pension contributions to be made in years when only minimal Schedule E remuneration has been taken from the company.

Even in what may be the five years when no earnings are necessary in order to sustain a defined-contribution tax regime pension contribution, it will nevertheless be worth seriously considering the national minimum wage (and state benefit) provisions referred to above before deciding whether to pursue a remuneration strategy founded wholly on dividends.


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