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
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 has 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.
On 19 July 2023 the Department for Business & Trade (DBT) laid new reporting regulations before Parliament for approval. The draft ‘Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023’ will, if approved, create a number of new corporate reporting requirements for very large UK Companies – defined in the Regulations as a ‘company with a high level of employees and turnover’. These regulations will not become law until they have been debated by both Houses in the Autumn but the draft regulations make clear the Government’s proposed approach to these new requirements. The draft regulations are in line with the direction set out in the Government’s response to its March 2021 White Paper ‘Restoring trust in audit and corporate governance’. As part of the new regulations, in-scope companies willl be required to provide additional information about distributable profits and purchase of own shares:
- disclosure of a distributable profits figure in the notes to the company’s accounts – this must state the company’s accumulated realised profits, or at least a minimum figure for such profits if it would involve unreasonable expense or delay to calculate the total accumulated realised profits. As this information will be included in the notes to the accounts, it will be subject to audit
- distribution policy statement in the directors’ report – this must explain the company’s policy on the amount and timing of distributions to shareholders over the short and medium term (including dividends and share buy-backs), and any risks or constraints to the implementation of that policy. The statement must also address how the policy has been implemented in the year.
The new requirements formalise, in law, aspects of reporting which many investors have been calling for for a while. The Regulations, which amend the Companies Act 2006, only apply to UK incorporated companies (public and private) meeting the relevant size criteria. For in-scope companies with equity share capital admitted to trading on a UK regulated market for the whole of their financial year beginning on or after 1 January 2025, these changes will apply to periods commencing on or after 1 January 2025. For other in-scope companies, they will apply to periods commencing on or after 1 January 2026.
The Financial Reporting Council (FRC) plans to consult separately on detailed non-statutory guidance to companies about good practice in complying with the new reporting statements required by the regulations. The FRC is expected to publish draft guidance for consultation by the end of 2023 or early 2024.
