When you set up a limited company, you’ll need at least one director to run it. But does that make them an employee of the business? It’s a question that causes plenty of confusion, and the answer isn’t always obvious.

However, it’s important for tax, legal, and employment rights reasons that you understand whether a director is considered an employee. As it affects everything from how they’re paid, to whether they qualify for benefits like sick pay or redundancy.

So today we’ll clear up the confusion by explaining what it means to be a director, when they are classed as employees, and how it can affect your business.

What is a company director?

A company director is someone appointed to run a limited company and make key decisions about its operations, finances, and compliance. They have a legal duty to act in the company’s best interests, ensuring it meets its obligations under Companies House and HMRC regulations.

Unlike regular employees, directors don’t always have a contract of employment. Instead, they hold an office—a formal position with specific responsibilities set out in the Companies Act 2006.

Their primary duties include:

• Ensuring the company follows financial and reporting rules
• Making strategic decisions to help the business grow
• Managing risks and keeping the company solvent
• Acting in the best interests of shareholders and stakeholders

Clearly different from an employee right? Well not always, while a director isn’t automatically classed as an employee, they can be one under certain conditions. Let’s explore when that applies.

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When is a director considered an employee?

A director can be considered an employee, but it depends on whether they have an employment contract with the company.

In general, a director is classed as an ‘officeholder’ rather than an employee. This means they are responsible for running the company but don’t automatically receive employment rights or a salary like a standard employee.

However, a director is considered an employee if:

• They have a contract of employment specifying their duties, salary, and terms of work.
• They receive a regular salary through PAYE (rather than just shareholder dividends).
• The company has control over their working hours, responsibilities, and performance, similar to an employee.
• They are entitled to employee benefits like sick pay, holiday pay, or a pension scheme.

On the other hand, if a director is only paid via dividends (only possible is a shareholder also) and doesn’t have an employment contract, they are typically classed as an officeholder, not an employee.

Why is this important to your business? Because it affects tax, having significant implications for National Insurance contributions (NICs), employment rights and dividend taxation. We’ll cover a full breakdown of all this next. 

Tax implications: director vs employee

Below is a clear and extensive explanation that lists all the ways tax treatment is different for directors when they are classed as ‘officeholders’ or ‘employees’. But for a quick snapshot we’ve created this handy table to make it super simple.

Here’s the full explanation how tax treatment differs:

1. Income tax and National Insurance (NI)

• Officeholder directors: If they don’t receive a salary, they won’t pay income tax or NICs. However, if they take a salary above the NI threshold, they must register for PAYE and may need to pay NICs.
• Employee directors: If they are on payroll and receive a salary, they must pay income tax and NICs under PAYE, just like regular employees.

2. Dividends vs salary

• Many directors pay themselves a combination of salary and dividends to minimise tax.
• Dividends are taxed at lower rates than salary and aren’t subject to NICs, making them a tax-efficient way for directors (who are also shareholders) to take income from the company.

3. Corporation tax impact

• A director’s salary is an allowable business expense, meaning it reduces the company’s taxable profits and, in turn, its corporation tax bill.
• Dividends, on the other hand, are not deductible as a business expense.

4. Pensions and benefits

• Employee directors may qualify for workplace pensions and other employee benefits, while officeholder directors typically do not.

Employment rights: What protections does a director have?

The employment rights of a director, again, depend on whether they are considered an employee or just an officeholder. This classification affects their entitlement to protections such as redundancy pay, unfair dismissal claims, and statutory benefits.

This is how it works:

1. Statutory employment rights

• Officeholder directors: Typically do not have employment rights unless they also have an employment contract.
• Employee directors: Are entitled to statutory rights like sick pay, holiday pay, maternity/paternity leave, and minimum wage protections (if applicable).

2. Redundancy and unfair dismissal

• Officeholder directors: Can only claim unfair dismissal or redundancy pay if they are also an employee under a contract.
• Employee directors: Can claim unfair dismissal and may be eligible for redundancy pay if they meet the qualifying conditions.

3. Workplace pensions

• Officeholder directors: Are not automatically enrolled in a workplace pension scheme.
• Employee directors: May be entitled to automatic enrolment if they meet earnings thresholds.

4. Disciplinary procedures and contracts

• Officeholder directors: Are subject to company law but not necessarily internal disciplinary procedures.
• Employee directors: Must follow company HR policies and may be subject to performance reviews and disciplinary processes like any other employee.

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What’s best for your business?

Every business is different, and whether a director should be treated as an employee depends on financial, tax, and legal considerations. Let’s recap what we have covered so you can use these learnings accordingly. 

Whether a director is considered an employee depends on their contractual relationship with the company. If they have an employment contract and receive a salary through PAYE, they are classed as an employee and gain employment rights. 

If not, they are simply an officeholder with fewer protections and different tax implications.

When deciding if a director should be an employee or just an officeholder, consider:

• Tax efficiency – A mix of salary + dividends can reduce tax liabilities. Employee directors pay PAYE & NICs, increasing costs.
• Employment rights – Employee directors get sick pay, holiday pay, and redundancy protections; officeholders don’t.
• Pension obligations – Employee directors may require auto-enrolment in a workplace pension.
• Compliance & legal clarity – Clear contracts prevent HMRC challenges and legal disputes.
• Business growth & funding – Some grants/investments prefer companies with directors on payroll.
• National Minimum Wage (NMW) – Employee directors may need to be paid at least NMW unless taking dividends. 

To ensure you’re structuring things correctly and tax-efficiently, it’s always best to seek professional advice. Not sure how to structure your director’s pay? Get in touch for expert guidance!

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