Distributable Profits

Introduction

Those unfamiliar with the law on distributions in the UK might assume that the decision by a UK company to pay a dividend depends on the need to retain cash to develop the business and to ensure that the claims of creditors can be met as they fall due. These factors are important but are only part of the story. Dividends – or distributions to use the legal term – can be made only out of ‘profits available for distribution’ as shown in the ‘relevant accounts’ drawn up in accordance with the applicable UK law and accounting standards. A dividend cannot, therefore, be paid in the absence of accumulated profits regardless of the extent of surplus cash balances or unused borrowing facilities.

Another complication is that only ‘realised’ profits may be distributed. The application of the law in the context of present day accounting standards is comprehensively addressed in TECH 02/17 Guidance on realised and distributable profits under the Companies Act 2006 issued jointly by the Institute of Chartered Accountants in England and Wales (ICAEW) and the Institute of Chartered Accountants of Scotland (ICAS).

TECH 02/17

TECH 02/17 replaced TECH 02/10 Guidance on the determination of realised profits and losses in the context of distributions under the Companies Act 2006. TECH 02/10 required updating as a result of changes to IFRS Accounting Standards and UK Accounting Standards (notably the introduction of FRS 102) and the need to provide additional guidance on a number of areas that have arisen in practice. The purpose of TECH 02/17 is to identify, interpret and apply the principles relating to the determination of realised profits and losses for the purposes of making distributions under the Act.

Our related Need to know publication on TECH 02/17 is available here.

Disclosure of distributable profits

There is no requirement under law or accounting standards for financial statements to distinguish between realised profits and unrealised profits or between distributable profits and non-distributable profits.  However, whilst there is currently no legal requirement to provide specific disclosures, investors now expect transparency around dividend policy and capital allocation.

In March 2018, as part of a wider consultation on insolvency and corporate governance, the Government sought views on, amongst other things, whether there was sufficient transparency and accountability to shareholders for dividend decisions and broader choices about how any surplus profits generated by a company should be allocated between investment in the company, payment of dividends, payments to reduce pension funds and other demands. A Government response, in August 2018, highlighted investor sentiment that there is a lack of transparency around dividend policy and practice including the links between the principal risks of the company and its future viability and a company’s ability to pay dividends now and in the future. Several respondents also indicated that there had not been the desired uptake of the better practice on disclosure included within the November 2015 and October 2017 research reports of the Financial Reporting Lab. The Government response identified potential ways to strengthen disclosure including requiring companies to disclose the audited figure for available reserves and distributable profits in their annual report and accounts.

Investors have indicated that they would like to see disclosure of an audited figure for available reserves and distributable profits within the financial statements, including greater clarity over the split between unrealised and realised profits included within those reserves. The Government found that a "significant number of respondents" regarded this as an important transparency measure for shareholders giving them more confidence about the underlying basis for decisions on dividends and helping to clarify the dividend resources available within the group.

Some investors believe disclosure of distributable reserves is a legal requirement of the Act and that without it the accounts do not provide a true and fair view. The FRC understands that under the Act there is no requirement for companies to separately identify distributable profits in the accounts, although it does recognise that such disclosure may be useful in particular circumstances.

In July 2023 the Department for Business & Trade (DBT) laid new reporting regulations before Parliament for approval proposing to create a number of new corporate reporting requirements for very large UK Companies.  It was proposed that in-scope companies provide additional information about distributable profits and purchase of own shares; specifically:

  • disclosure of a distributable profits figure in the notes to the company’s accounts 
  • distribution policy statement in the directors’ report 

However, in October 2023, the UK government withdrew its proposals, citing concerns by companies about imposing additional reporting requirements. Instead, the government has stated that it will pursue options to reduce the burden of red tape on businesses through simplifying and streamlining existing reporting. The government’s statement also reiterated that it remains committed to wider audit and corporate governance reform, including establishing the Audit, Reporting and Governance Authority (ARGA) to replace the existing Financial Reporting Council (FRC), and that it will bring forward legislation to deliver these reforms when Parliamentary time allows.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.