Issue 95 - October 2007

Welcome to October’s update. As you will be aware, the Government has attempted to harmonise the introduction of new employment law, and on 1st October several pieces of legislation came into force. These included some important provisions of the Companies Act 2006 relating to directors’ duties. Included within this update is an article discussing how HR practitioners need to react to this change in the law. But first, here is the usual case update:

Arctic Systems: Lords put freeze on HMRC’s attempts to close tax “loophole”

Her Majesty’s Revenue and Customs suffered a recent defeat in the House of Lords in the case of Jones v Garnett. The dispute was over whether the owners of a small family business (Arctic Systems) were avoiding tax. The twist is that whilst HMRC lost the case, the Government has pledged to pass legislation to close this “loophole”.

Mr and Mrs Jones each owned an ordinary share in Arctic Systems. The company was a vehicle through which Mr Jones provided IT consultancy services to other firms. Mr and Mrs Jones paid themselves small salaries and the rest of the firm’s profits were distributed to them through share dividends. This had two advantages. Firstly, National Insurance is not payable on dividends. Secondly, it was tax efficient to pay Mrs Jones dividends and use her lower tax bracket.

HMRC argued that this arrangement fell foul of anti-avoidance legislation. The Lords thought otherwise. They concluded that it fell within an exception which permits spouses to make gifts to one another. HMRC is advising that tax returns for the year 2006/2007 should be completed in accordance with this decision, and will be issuing guidance shortly.

The Government argues that it is unfair that people who divert income in these types of arrangements are not paying tax on what are, in reality, their own earnings. People in the Jones’ situation need to bear in mind that whilst Arctic Systems’ arrangements may be legal for the time being, the Government is intent on changing the law.

Can a director and majority shareholder be an employee?

In Nesbitt and Nesbitt v Secretary for Trade and Industry the employment appeal tribunal reviewed the authorities and confirmed that it is possible for a director, who is also a majority shareholder, to be an employee.

Mr and Mrs Nesbitt owned 99.9% of the shares in APAC Computer Training Limited. They were also contracted by the firm to act as directors.

The Nesbitts were keen to establish that they were employees so that they could seek redundancy payments when the company became insolvent.

The employment tribunal decided that the Nesbitts were not employees as they controlled the company. This decision was reversed by the Employment Appeal Tribunal. It held that an individual’s control of a company is just one consideration when determining his status. Besides, in this case the reality was that the directors ceased to have control over the company when the liquidator was appointed. The directors had written contracts and their dealings with the company were consistent with a genuine employment relationship

Employer prosecuted for breaching minimum wage legislation

The Revenue and Customs Prosecutions Office has brought its first criminal prosecution under the National Minimum Wage Act 1998 (“the Act”). Usually Her Majesty’s Revenue and Customs (HMRC) issues enforcement and penalty notices to make recalcitrant employers comply with the law. However, it has demonstrated a new willingness to pursue employers through the courts.

It is now even more important that employers ensure they do not breach the minimum wage legislation. As a reminder, this is a list of the six potential offences under the Act:

• An employer refuses or wilfully neglects to pay national minimum wage
• A person fails to keep or preserve records
• A person knowingly causes or allows false entry in records
• A person produces or furnishes false records or Information
• A person delays or obstructs compliance officer
• A person refuses or neglects to answer any questions or produce documents for compliance officer

Quickfire!

• The recent case of McCarthy made clear that the absence of an express clause allowing an employer to withhold and pay over tax and NICs to the Revenue will not prevent the employer from making tax payments and demanding repayment by the employee
• The national minimum wage went up on the 1st October. The main rate for 22 year olds and above is now £5.52, the development rate for those aged between 18 and 21 is £4.60, and the rate for workers aged 16 to 17 years is £3.40.
• In her last interview as Chair of the Equal Opportunities Commission, Jenny Watson chose to draw attention to the many thousands of equal pay claims that are clogging up the tribunal system. The number of equal pay claims rose by 115% from the period 2005-06 to 2006-07. She warned that whilst most claims are brought against public institutions at present, the focus could shift to the private sector in the future. The pay gap between full time male and female workers is still, on average, 17.2%. Mrs Watson recommended that companies be given a three year moratorium during which they would be immune from equal pay claims, in exchange for them agreeing to review their payroll systems.
• The Commission for Equality and Human Rights came into being on the 1st October. This body has replaced the Equal Opportunities Commission, the Commission for Racial Equality and the Disability Rights Commission.
• The Racial and Religious Hatred Act 2006 came into force on the 1st October. This makes it illegal to stir up hatred against persons on racial or religious grounds. Corporate entities can be guilty of criminal offences under this Act, as can directors, managers, secretaries and other company officers.

Companies Act 2006: Directors’ Core Duties

The common law duties directors owe to their companies are being recognised in statute for the first time. The Companies Act 2006 is introducing a new set of statutory duties in two waves. The first came into force on the 1st October, and the second will take effect on 1st October 2008. Although enshrining the duties in statute has underlined their importance, the changes are not purely symbolic. Human resources departments need to have an understanding of what they entail, and should be reviewing the ways in which they draw them to the attention of directors.

Promoting the Success of the Company

Of all the duties that came into force on 1st October, the duty to promote the success of the company is arguably the most significant. It has generated much debate over whether it marks a shift in the relationship between companies and the community, and how it will affect the way directors record their decisions.

Directors must have this duty in mind when exercising their powers. In the context of a company, “success” is likely to mean “a long term increase in value”. In pursuing this aim, directors should think about the following factors:

• the likely consequences of the decision in the long term
• the interests of the company’s employees
• the need to foster the company’s business relationships with suppliers, customers and others
• the impact of the company’s operations on the community and the environment
• the desirability of the company maintaining a reputation for high standards of business conduct
• the need to act fairly as between the members of the company

Directors merely have to consider these interests. So long as they act in good faith and with reasonable care, skill and diligence, they can act in any way they think will promote the success of the company.

The GC100 (the Association for the General Counsel and Company Secretaries of FTSE 100 companies) has advised that directors should not have to evidence their consideration of the factors in every situation. However, it does recognise that it will be appropriate on occasion to record a director’s thinking.

Awareness

Directors need to be educated about the new duties. Human resources departments should consider taking the following steps:

• Hold briefing and training sessions for existing directors
• Provide new directors with induction sessions
• State that directors will be subject to the duties in offer letters and service agreements
• Ensure that there is not a conflict between a director’s statutory duties and his obligations to the company in his service contract

The new statutory duties are as follows:

• Duty to act within powers
• Duty to promote the success of the company
• Duty to exercise independent judgement
• Duty to exercise reasonable care, skill and diligence
• Duty to avoid conflicts of interest
• Duty not to accept benefits from third parties
• Duty to declare interest in proposed transaction or arrangement with the company

It is in the interests of companies to ensure that directors understand and comply with their duties. It will also help to avoid potential litigation. This is especially important as shareholders are being given greater powers under the Companies Act 2006 to bring actions on behalf of their corporations.

• JOLYON BERRY t: 01473 406356
• JEANETTE WHEELER t: 01603 756427
• KATIE DAVIS t: 01603 756432
• DEBORAH IVES t : 01603 756433
• LOTTIE HAMMOND t: 01603 756419
• LISA HAYWARD t: 01473 406316
• MATTHEW NEWNHAM t: 01603 756412
• SONYA O’REILLY t: 01603 756413

Birketts LLP are proud sponsors of the EDP’s Norfolk Recruitment Awards 2007 – for more details see here.

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