What are Company Distributions?
Company distributions in the UK
This guide sets out a high-level summary of the rules and procedures applicable to “distributions” made by UK incorporated private limited companies. Additional requirements can apply to distributions by UK public limited companies, listed investment companies and insurance companies with long term business and these are not covered in this note.
Company distributions enable a company’s shareholders/members to extract value from the company and, particularly with regards to owner-managed businesses, can be a more tax-efficient means for an owner to receive income (as opposed to being paid a salary). The distributions regime has rules and procedures set out in the Companies Act 2006 (the “Act”).These rules and procedures are primarily focused on protecting a company’s creditors by preventing the extraction of value in circumstances which would be to their detriment.
Types of distributions
A distribution is defined as “every description of distribution of a company’s assets to its members, whether in cash or otherwise” (s829(1) of the Act). Company distributions can take many forms, including: gifts or charitable donations; transactions at an undervalue; assumption of a liability; surrendering tax losses to a parent company; payment to a shareholder in respect of its shareholding (even where the payment obligation is set out in a contract); and cash payments (often in the form of cash dividends).
Dividends can take the form of:
- final dividends: paid once a year and calculated after the annual accounts have been finalised; and
- interim dividends: paid at any time during the year and calculated before the annual accounts have been finalised.
The general principle is that while interim dividends only require to be declared by the directors, final dividends require shareholder approval upon a value recommended by the directors (and the shareholders cannot approve an amount that exceeds the directors’ recommendation). However, a company’s articles of association should always be checked before declaring a dividend (as they can contain bespoke rules).
Should a company wish to declare a non-cash dividend and therefore distribute a non-cash asset to its shareholders (for example, a property), this is referred to as a distribution in kind (or a dividend in specie). A company’s articles should be reviewed to ensure they do not prohibit such distributions in kind.
Requirements for a company distribution
The basic requirements for a distribution are:
- sufficient profits: the company must have sufficient distributable reserves available which are at least equal to the value of the distribution. A company’s “distributable profits” are its accumulated realised profits (not previously distributed or capitalised) less its accumulated realised losses (not previously written off in a reduction or reorganisation of capital) (s830(2) of the Act); and
- relevant accounts: the distributable reserves available must be justified by reference to the company’s “relevant accounts”.
A company’s “relevant accounts” will normally be its latest statutory (annual) accounts. However, if the distribution relates to a newly incorporated company (which has not yet prepared its first set of annual accounts), a set of initial accounts can be drawn up. In circumstances where a distribution cannot be justified by the previous annual accounts (due to a recent increase in performance), a set of interim accounts can be drawn up. In each case, there are statutory requirements for these accounts and therefore legal and accounting advice should be sought before relying on them.
As interim dividends are declared mid-way through a company’s financial year, the directors should justify them by reference to the last annual accounts alongside more recent management accounts (showing that they have considered the company’s up-to-date financial position). The directors are also required to look forward to consider any known upcoming liabilities which may affect the company’s ability to pay its debts as they fall due (for example, an upcoming litigation settlement payment or corporation tax liability).
With regards to cash dividends, the amount of the distribution is easily identifiable as the value of the cash payment. There are more intricate rules for determining the amount of a distribution on a dividend in kind (s845 of the Act). If the company is transferring a non-cash asset to a shareholder (or to a sister company within its corporate group):
- at its market value, then there is no distribution and therefore the company does not need distributable profits in order to make the transfer;
- at its book value (or above), the distribution is valued at zero (and therefore the company can lawfully make the transfer provided it has at least £1 of distributable reserves); or
- at less than its book value, the distribution is equal to the difference between the net book value and the amount of consideration actually paid (and therefore the company requires distributable reserves equal to the difference in order to lawfully make the transfer).
A shareholder will be liable to repay an unlawful distribution if it knows (or has reasonable grounds to believe) the distribution contravenes the requirements contained in the Act. Knowledge will often be implied for companies whose shareholders also act as directors.
Further information on company distributions
We hope that this provides you with a helpful summary of company distributions. This guide is not legal advice, but should you require any further advice or assistance, please do not hesitate to contact us.
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