Under section 830 of the United Kingdom Companies Act 2006, a company may only make a distribution out of profits available for the purpose (that is, in summary, its accumulated, realised profits less its accumulated, realised losses). UK group companies lacking distributable profits may present a blockage in the flow of distributions throughout the group to the ultimate parent company. Under both the UK Companies Act 2006 and at common law, distributions are made by individual companies and not by groups.
If the UK company has share capital and/or share premium account equal to or greater in magnitude to the deficit on P&L, it may be possible to effect a reduction of share capital or cancellation of share premium account to eliminate the deficit and create distributable profits. Company law simplification measures introduced in October 2008 have enabled UK companies to carry out this procedure by way of a special resolution combined with a solvency statement (rather than by way of a court sanctioned procedure as was previously required).
If the UK company has a deficit on P&L but negligible share capital and/or share premium account, it may be worth considering transferring assets held by its parent to the UK subsidiary in consideration of the issue of shares by that subsidiary, which can then be reduced, thereby creating distributable profits.
- Alternatively, if the UK company has assets the market value of which exceeds their book value, it may be advisable to sell them to another group company. Provided the sale resulted in the UK company recognising a realised profit the distributable reserves created would enable a dividend to be paid (provided the company does not have a deficit on P&L).
The sale would have to be for a “qualifying consideration” which comprises cash; an asset for which there is a liquid market; or, the release, settlement, or, with certain exceptions, the assumption by another party of all or part of a liability of the company.
In the case of intra-group transactions, such as dividend payments from a subsidiary to its parent, or the sale of assets by or to a parent, the qualifying consideration in the form of the dividend or sales proceeds must be derived from the payer’s own resources, and without recourse to a loan or guarantee of a loan by the parent.
- In other circumstances, it may be possible to capitalise a UK company’s undistributed net income (such as current earnings) under Regulation 110 of Table A (assuming it forms part of the UK company’s articles) even though it may not constitute distributable profit. This provision can only be used to capitalise undistributable profit to the extent that it exceeds any deficit. Therefore, if the UK company has a share premium account, it is preferable to cancel the share premium account first to eliminate the deficit (or as much of the deficit as possible) before carrying out the capitalisation under Regulation 110. This will enable a greater amount of the reserves to be converted to capital.
A reduction of the newly created share capital is then carried out to create distributable reserves (as described above).
By way of example, let us suppose the UK company has:
a share premium account of £2 million
a negligible amount of issued share capital
a deficit on P&L of £1.5 million
undistributable profit of £8 million
Such a company would cancel its share premium account, thereby eliminating the deficit of £1.5 million and creating distributable reserves of £0.5 million. It would then capitalise the undistributable profit of £8 million under Regulation 110, followed by a reduction of that share capital, creating total distributable reserves of £8.5 million.
Following the preparation of the relevant accounts by the UK company’s accountants, the requisite procedures can be completed in a matter of weeks.