On 18 March 2021, BEIS published its consultation paper on restoring trust in audit and corporate governance. The paper contains a wide range of proposals which are designed to strengthen the UK’s framework for major companies and the way in which they are audited. We are working our way through the paper and will publish a series of articles and posts on some of the key proposals.
Our first post looks at the approach to realised profits and losses and the payment of dividends set out in the white paper.
What's the current position?
Currently, the Companies Act 2006 provides that a company may only make a distribution out of profits available for the purpose. A company's profits available for distribution are its accumulated, realised profits, so far as not previously utilised by distribution or capitalisation, less its accumulated, realised losses, so far as not previously written off in a reduction or reorganisation of capital duly made.
References to realised profits and realised losses are to such profits or losses of the company as fall to be treated as realised in accordance with principles generally accepted at the time when the accounts are prepared.
The joint ICAEW and ICAS guidance TECH 02/17BL, Guidance on Realised and Distributable Profits under the Companies Act 2006 is an established reference point when determining realised profits and losses. The white paper notes that this "guidance seeks to distil current generally accepted accounting practice and is relied on extensively by the profession but has no formal legal status".
What are the issues?
The white paper identifies three key issues:
- First, there is no fixed definition of realised profits and losses.
- Second, there is a lack of transparency as there are currently no explicit requirements for financial statements to disclose the total amount of distributable profits.
- Third, the current regulatory focus on capital maintenance and realised profits and distributable reserves is backward looking.
The white paper contains the following proposals in relation to dividends and capital maintenance:
- Disclosure of the distributable reserves in the financial statements: companies (the parent company in the case of a group) should disclose the total amount of reserves that are distributable, or – if this is not possible – disclose the “known” distributable reserve, which must be greater than any proposed dividend;
- Disclosure of estimates of a group’s dividend-paying capacity: in the case of a group, the parent company should provide an estimate of distributable reserves across the group - the government envisages this requirement applying to listed and AIM companies only; and
- Directors’ statement about the legality of proposed dividends and the effects on the future solvency of the company: directors should state that any proposed dividend is within known distributable reserves and that payment of the dividend will not, in the directors’ reasonable expectation, threaten the solvency of the company over the next two years. The consultation seeks views on which companies should be covered by this requirement.
The white paper also invites views on proposals to give the FRC’s successor body, the Audit, Reporting and Governance Authority, new powers in relation to how companies calculate their distributable reserves. Currently, guidance in this area rests with the professional accountancy bodies - hence TECH 02/17BL.
The proposals are aimed at addressing weaknesses in the current framework of rules governing dividend payments, rather than replacing them with a completely different system.
What's the likely impact?
We anticipate that this will have a limited impact on most interim and final dividends declared by quoted companies although there may be some caution while any new regime beds in - in some cases this could reduce the amount paid out to shareholders. The government is alive to this concern and the consultation states that: "In making its proposals, Government is aware of the importance of dividends to pension funds and savers and to the efficient re-allocation of surplus capital to other parts of the economy. It is therefore keen understand any potential adverse effects and to avoid measures which will unnecessarily reduce the level of dividends paid by UK companies."
The most significant impact is likely to be on pre-closing dividends - as the two year look forward period will largely cover the period post closing when the company is controlled by the buyer. Transactions which involve a refinancing followed by a significant dividend are likely to be subject to greater scrutiny.
"The legal framework is well established, but high profile examples of companies paying out significant dividends shortly before profit warnings and, in some cases, insolvency, have raised questions about its robustness and the extent to which the dividend and capital maintenance rules are being respected and enforced."