Refreshed guidance on realised and distributable profits has been issued by the ICAEW and ICAS to reflect the introduction of FRS 102, acting as a reminder of the importance of the rules about distributions in company law.
Guidance on realised and distributable profits under the Companies Act 2006 (TECH 02/17BL) was issued in April 2017 by the ICAEW and ICAS (‘the Institutes’).
During the results season three listed companies disclosed that they had made unlawful dividends and share buy-backs totalling £511m in transactions over 17 years, attracting press comment. It is a reminder that, even for well-managed companies, it is all too easy to fall foul of company law rules on distributions. At the same time there is continued appetite from some investors for disclosure of the balance of distributable profits. It is timely that the Institutes have issued refreshed guidance on distributable profits.
The refresh followed the introduction of "new UK GAAP" and intends to reflect the new accounting framework and to refresh the wording in some places.
The guidance explains, as did the old guidance, the statutory procedures in relation to distributions. Most importantly these include that if the last company-only annual accounts do not include sufficient distributable profit then a set of interim company-only accounts are required. Critically, for a plc, these need filing with Companies House before the distribution (or share buy-back) is made - omitting to do so makes it unlawful.
The guidance includes an expanded explanation of the case law on what counts a distribution; it doesn’t matter what label a transaction is given, but it is the purpose and the substance of a transaction that matters. Particular reference is made to transactions with shareholders or sister companies at an undervalue. This is relevant to intra-group movements of assets and businesses that might affect the profit flow to the top company.
Help is provided for the first time to address the accounting consequences for intra-group off-market loans under FRS 102 (or IFRSs) which are recognised initially at fair value rather than face value (by lender and borrower), eg. an upstream interest-free term loan is a distribution by the lender.
Whilst the chapter on pensions has been completely rewritten, removing redundant material, e.g. on SSAP 24, the principles are unchanged. However, they are particularly relevant under FRS 102, as at least one entity in a group pension scheme will recognise the pension surplus or, usually, deficit – a major effect on distributable profits in that entity which potentially affects the profit flow to the top company.
As companies need to be mindful of unrealised gains to avoid unlawful distributions, they might choose to provide disclosure about the level of distributable reserves. This would show shareholders that the company has considered the quality of their reserves and might provide them with much appreciated transparency. Investors have said that they believe this to be relevant information, however, generally asking for it on a group basis. Companies need to be aware that deriving and presenting such information might be costly and complex, where for example a group operates internationally and might have to consider distribution rules of entities in a variety of jurisdictions and will also require judgement, for example about the ability to extract value from certain investments.
View the full guidance from the ICAEW and ICAS here.
UK Head of Accounting Advisory Services, KPMG