UK: Dividends and Distributions

Last Updated: 31 March 2004
Article by Jonathan Deverill

Many companies will now be considering paying dividends or making other distributions, for example following a 31 December year-end or in anticipation of a 31 March or 5 April year-end. This article seeks to explain the basic legal principles relating to dividends and distributions, notes certain recent developments in the accounting field which have an impact and concludes by addressing some practical issues which fall to be considered. For the purposes of this article, we have not addressed the tax implications relating to dividends and distributions.

Legal Principles

It is a fundamental principle of company law that a company should maintain its capital and that capital can only be extracted and returned to shareholders in a limited number of ways. One such way is through the payment of a lawful dividend or the making of a lawful distribution. Section 263(2) Companies Act 1985 (the "Act") defines "distribution" as meaning (subject to four specified exceptions) "every description of distribution of a company’s assets to its members, whether in cash or otherwise"; this includes dividends and so the Act and, hereafter, this article do not refer separately to dividends.

The Act sets out what assets a company is permitted to distribute and contains additional rules which apply only to public companies. Section 263(1) of the Act states that a company may only make a distribution out of profits available for that purpose ("distributable profits"). These are the company’s accumulated, realised profits (so far as not previously distributed or capitalised) less its accumulated, realised losses (so far as not previously written off in a reduction or reorganisation of its share capital). As noted in Part 2 below, the identification of "realised" profits and losses is a matter of both law and accounting practice.

For public companies, section 264 of the Act imposes an additional requirement. A public company may only make a distribution at any time:

(a) if at that time the amount of its net assets is not less than the aggregate of its called-up share capital and undistributable reserves; and

(b) if, and to the extent that, the distribution does not reduce the amount of those assets to less than that aggregate.

There are additional requirements for insurance and investment companies which are outside the scope of this article, as are certain special provisions which apply to distributions by banking companies. Section 281 of the Act states that the statutory provisions of the Act relating to distributions are without prejudice to any enactment or rule of law, or any provision of a company’s memorandum or articles, restricting the sums out of which, or the circumstances in which, a distribution may be made. It should be borne in mind that, as a result of the Aveling Barford decision, a sale at an undervalue by a company to its parent or a sister subsidiary could be treated as a distribution for the purposes of the Act.

Whether a company can make a distribution at a particular time also depends upon the position as shown by the company’s accounts. For this purpose, it is necessary to refer to the company’s own individual accounts; it is irrelevant whether, on a consolidated basis, any group in which the company is included has sufficient distributable profits.

In accordance with section 270(2) of the Act, the amount of a distribution which may be made is to be determined by reference to the following items as stated in the company’s individual accounts:

(a) profits, losses, assets and liabilities;

(b) provisions of any of the kinds mentioned in paragraphs 88 and 89 of Schedule 4 to the Act (depreciation, diminution in value of assets, retentions to meet liabilities, etc.); and

(c) share capital and reserves (including undistributable reserves).

The Act also identifies which accounts of the company are relevant for this purpose. These will be the last audited annual accounts of the company, except that:

(a) where the distribution is proposed to be declared during the company’s first accounting reference period, or before any accounts are laid in respect of that period, one instead refers to "initial accounts" of the company; and

(b) where the last annual accounts show insufficient distributable profits, or an insufficient level of distributable profits taking account of distributions made since the preparation of those accounts, one instead refers to "interim accounts" of the company.

When reliance is placed for this purpose on the last audited annual accounts of the company, under section 271 of the Act those accounts must (amongst other things) have been properly prepared in accordance with the Act and show a true and fair view of the state of the company’s affairs as at the balance sheet date and of the company’s profit or loss for the relevant accounting period. In addition, the auditors must have reported on those accounts and, if their report is qualified in any way, they must state in writing whether the matter by reference to which their report is qualified is material for determining whether the distribution can lawfully be made; and a copy of the auditors’ statement must be laid before the company in general meeting.

Private companies using initial or interim accounts to justify a distribution need only ensure that such accounts enable the directors to determine whether that distribution can lawfully be made by reference to the matters set out in section 270(2) of the Act (referred to above) and, therefore, a decent set of management accounts may be sufficient for this purpose. In the case of public companies, however, additional requirements are imposed for both interim and initial accounts. One of these is that the set of accounts prepared must show a true and fair view of the state of the company’s affairs as at the balance sheet date and of the company’s profit or loss for the period for which such accounts are made up.

2. Accounts And Accounting Principles – An Evolving Relationship

As mentioned in Part 1 above, the identification of "distributable profits" is determined by reference to both legal and accounting principles. We have already seen that "distributable profits" are calculated using a company’s "realised profits" and "realised losses"; and, by section 262(3) of the Act, "realised profits" and "realised losses" are profits and losses of the company "as fall to be treated as realised in accordance with principles generally accepted, at the time when the accounts are prepared, with respect to the determination for accounting purposes of realised profits or losses".

Following a consultation process, new guidance on the determination of realised and distributable profits (and losses) under the Act was issued in March 2003 by The Institute of Chartered Accountants in England and Wales and The Institute of Chartered Accountants of Scotland, in a document entitled "Tech 7/03 – Guidance on the Determination of Realised Profits and Losses in the Context of Distributions under the Companies Act 1985" ("Tech 7/03"). Tech 7/03 supersedes Technical Releases 481 and 482, issued in September 1982.

In summary, Tech 7/03 defines a "realised profit" as a profit arising in one of several situations, including:

(a) on a transaction where the consideration received is "qualifying consideration" (broadly, cash or certain types of cash-equivalent, such as an asset for which there is a liquid market) or as a result of some other event which results in the company receiving "qualifying consideration" without itself giving consideration;

(b) profits arising from use of the "mark to market" method of accounting, where it is proper for the company to adopt that method;

(c) profits arising on an unrealised profit becoming realised in certain circumstances or on the reversal of a loss previously regarded as realised; and

(d) following certain reductions or cancellations of capital by a company.

In contrast, Tech 7/03 requires all losses to be treated as realised except where law, accounting standards or Tech 7/03 otherwise provide. Tech 7/03 notes that certain published accounting standards require certain specific events to be treated in a certain way as regards their impact on the realisation (or otherwise) of profits or losses. When determining whether a company has a realised profit, transactions and arrangements must be looked at as a whole, particularly if they are artificial, linked or circular. It therefore follows that intra-group transactions should be looked at carefully and further guidance on that is set out at Appendix A to Tech 7/03.

Certain sections of the Act contain specific rules which affect whether certain profits or losses can be treated as realised. These include:

(a) section 263(4) – a company must not apply an unrealised profit in paying up debentures or any amounts unpaid on its issued shares;

(b) section 275 – contains several rules, including one to the effect that, save as provided in that section, most provisions in a company’s accounts must be treated as a realised loss for the purpose of calculating a company’s distributable profits; and

(c) section 276 – where a company makes a distribution of or including a non-cash asset, and any part of the amount at which that asset is stated in the accounts by reference to which the distribution is made represents an unrealised profit, that profit is treated as a realised profit when determining, in particular, whether the distribution in question can lawfully be made.

3. Some Practical Considerations

The legal and accounting principles described in Parts 1 and 2 above are relevant in determining whether a company can make a distribution and, if so, by reference to which items in which set of accounts. However, companies wishing to make a distribution should also have regard to a number of considerations of a more practical nature and some of these are described in more detail below.

A company should not make a distribution to its members unless it is in the company’s best interests to do so. In assessing this, the directors should take into account, amongst other things, the consequences of the distribution for the company’s solvency and cash-flow. It may be advisable, even where not strictly required, to confirm with the company’s auditors that they are comfortable with the company’s proposed distribution.

The memorandum and articles of association of the company must always be examined for provisions which might affect whether the company can make a distribution, not least because of section 281 of the Act (referred to above). Similarly, contracts to which the company is a party may contain such provisions, especially loan agreements or contracts creating convertible instruments.

A company’s articles of association will usually state that distributions (not exceeding the amount recommended by the directors) are to be approved by the company in general meeting. Such a distribution, a "final" distribution, constitutes a debt owed by the company to the member. A company’s articles will also usually allow the directors to approve distributions by resolution of the board – this is called an "interim" distribution and can theoretically be revoked before payment as in this case no debt is created.

Where a non-cash distribution is proposed, express authority in the company’s memorandum or articles of association is required, failing which a special resolution of the company approving that distribution would be needed.

Where a distribution is made by a company in contravention of the Act and, at the time of the distribution, the member concerned knew or had reasonable grounds for believing that such distribution was being made in breach of the Act, that member is liable to repay that distribution (or its cash value, in the case of a non-cash distribution) to the company.

Additional rules apply to listed companies. A company listed on the Official List maintained by the UK Listing Authority must announce decisions by the board on dividends without delay and not later than 7.30 am on the next following business day (Listing Rule 9.35). A company with an AIM listing must announce without delay any decision to make a payment in respect of its AIM-listed securities, specifying the net amount payable per security, the payment date and the record date (AIM Rule 15). 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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