This site uses cookies to provide you with a more responsive and personalised service. By using this site you agree to our use of cookies. Please read our cookie notice for more information on the cookies we use and how to delete or block them.
The full functionality of our site is not supported on your browser version, or you may have 'compatibility mode' selected. Please turn off compatibility mode, upgrade your browser to at least Internet Explorer 9, or try using another browser such as Google Chrome or Mozilla Firefox.

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. This principle was not seen as contentious or difficult to apply when it was introduced into the law in the early 1980s. The fundamental accounting concept of prudence dictated that profits were recognised only when realised in the form either of cash or of other assets, the ultimate cash realisation of which could be assessed with reasonable certainty.

Financial reporting has moved on a lot since then.  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) in April 2017.

TECH 02/17

TECH 02/17, which was published in April 2017, 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 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

Currently there are no specific requirements on a company to disclose their capital allocation and dividend policies. However, there are growing calls from investors who are challenging company disclosure in this area; their expectation is that there should be greater transparency around dividend policy and capital allocation. Many investors see a lack of transparency in how companies allocate surplus capital between things such as investment, dividends and other important areas such as pension contributions or deficit reductions. Many see these decisions as vital to long-term success of the companies in which they invest.  

Some investors are also calling for an audited figure to be disclosed within the annual reports and accounts.

Further pressure on companies to make fuller disclosure has recently come from the Investment Association. In May 2019, they issued a statement calling on all listed companies to disclose their distribution policy within their annual reports and accounts, which would include such things as decisions over when and how to return capital to shareholders considering dividends, share buy-backs and any other capital distributions. Guidance on exactly what they envisage such disclosure to look like is expected in the autumn.  The Investment Association has also indicated that it will make recommendations to the Government as to whether a shareholder vote on the distribution policy and/or yearly distributions should be mandatory.

This area is also on the political agenda and there are two consultations that have brought the topic into political focus:

  • BEIS Select Committee, in March 2019, in its ‘Future of audit’ report commented that there was “…little compliance with and enforcement of the capital maintenance regime’, highlighting that there a number of high-profile instances where companies had paid unlawful dividends.
  • The Government's response to its consultation on Insolvency and Corporate Governance August 2018.  This supported investors’ calls for change and highlighted that investors also wanted capital allocation and dividend policy disclosures to provide linkage to areas of the annual report such as principal risks and viability

The FRC has indicated that it expects many companies to included disclosure of capital allocation and distribution policy within their s172 reporting; this new requirement being effective for periods beginning on or after 1 January 2019.  Hence the expectation is that compliance should result in fuller disclosure in this area. 

However, the government has made clear that it will legislate to require companies to disclose their capital allocation and dividend policies if what it sees as ‘sufficient progress’ is not made through companies making voluntary disclosure especially through s172 reporting.  The August consultation 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.

The reports published by the Financial Reporting Lab (November 2015 and an update report in October 2017) provide practical guidance to assist companies in this area.

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.