Company Law - Capital Dividend - Essay Example

?Company Law - Capital= Dividend Table of Contents Table of Contents 2 Introduction 3 Understanding the Laws Relating To Dividends in UK 4 Practical Issues That Companies Need To Be Consider In Relation To Dividends 9 Analysis of Dividend Law in UK 11 Conclusion 14 References 16 Introduction Since the formation of companies, there has been constant discussion regarding the responsibilities entitled to directors for the efficient performance of the organisation as well as the consideration and values rendered towards the interests of the shareholders. It is worth mentioning in this regard that directors are deemed to be responsible for the transparency and efficiency of all activities that are performed by the company. Hence, directors are liable to perform their duties and exercise their powers for the best interest of company. In this regard, directors should be considering the issue of shareholders as well as their interest should also be considered carefully1. Furthermore, apart from framing strategies for the obtainment of greater value, they should also consider how this value is to be distributed among the investors and other stakeholders possessing a certain degree of interests in the company profits. Consequently, while a company intends to generate profits and share it partially among the shareholders, one of the important issues that need to be considered by the directors is whether the distribution of dividends or payments to shareholders are made in accordance to Companies Act practiced within the region2. In recent times, there has been a strict line established in the UK in relation to compliance with legal requirements for distributions. In this regard, directors may find themselves at risk of liability if they grant dividends in breach of the rules; even if the breach tends to be technical other than substantive. The laws governing distributions of dividends in the UK are particularly incorporated in the Part 23 of Companies Act 2006. The law is applicable in both the contexts where accounts are prepared according to Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS)3. The Companies Act 2006 makes it mandatory for all the companies to follow the rules and regulations prescribed in the Act owing to which, any sort of non-compliance tends to generate legal actions against the company. With this concern, the paper intends to provide a clear understanding of dividend sharing laws, governing in the context of UK Companies and further makes analysis of issues that need to be considered by both private and public companies in the course of making payments to shareholders. Understanding the Laws Relating To Dividends in UK According to Part 23 of Companies Act 2006, distribution to shareholders means “every description of a company assets to its members, whether in cash or otherwise, subject to certain exceptions”4. The key aspects that Companies Act 2006 states affirms any company in the UK to be eligible to make distributions only out of their profits earned. Accordingly, the profits available for the distribution is determined as total accumulated realised profits less total accumulated realised losses5. It is worth mentioning on this ground that not everything documented as profits is realised in certain circumstances, where the accounts are prepared under the standards of IFRS. For instance, a gain on revaluation of companies’ investment property can be documented as profit under the rules prescribed by IFRS; but it cannot be referred as a realised profit6. In addition to this, public companies are required to decipher extra cautious attitude and check that their available net assets, after making distribution, do not fall less than the aggregate called-up share capital as well as reserves which are not assigned for distribution, such as share premium accounts, revaluation reserves and capital redemption reserves. Furthermore, the Act also prescribes those directors of the companies to consider their fiduciary duties prior to distribution of dividends to shareholders in order to ensure that company is in a position to settle its debt efficiently. Hence, the directors are required to safeguard the interests of the company and ensure that the company shall be solvent even after the distribution of the dividends7. Additionally, the Companies Act 2006 prescribes that distributions made to the shareholders are justified on the basis of profits reflected in the relevant accounts. Furthermore, as a basic rule, all the limited companies should ensure that these relevant accounts are most recent that are signed by the concerned authorities and circulated to members of the company for verification8. Although, if the company fails to decipher to present updated and most recent annual accounts, even if the company has made considerable profits in a fiscal year, in such cases the Act restricts the payment of dividend to its members. Contextually, the company is required to prepare the most recent interim accounts that depict sufficient distributable profits in order to support the dividend payment9. At the same time, if the directors intend to distribute dividends prior to annual accounts, they shall require to prepare initial accounts as a supporting instrument for the proposed dividends. Such cases are usually common with the company that has been newly incorporated. With respect to private companies, both interim and initial accounts, act to be sufficient materials for directors to make judgements relating to profit and loses, reserves and provisions as well as assets and liabilities. Additionally, private companies are not required for any kind of filing, unlike the public companies10. However, in the case of public companies, the rules are quite stringent. As opposed to private companies, public companies are required to prepare interim accounts in accordance to Companies Act 2006 and further the company has to file at Companies House before making distribution. Notably, the interim account prepared does not require compulsory auditing. Conversely, if the company intends to prepare initial accounts for distribution of dividends, the accounts need to be audited essentially. Additionally, the other requirements of initial accounts are similar to that of interim account in several instances. Similar to payment of dividend in cash, the dividend payments in kind also requires complying with certain rules and regulations of the Companies Act 2006. In this regard, rules governing the payment of dividends in kind are considered to be crucial in certain situations, wherein assets are transferred from subsidiary to parent company or from one subsidiary to another subsidiary. In addition, these rules and regulations are considered to be equally important in the cases when assets are sold to the members of the company or to the other companies that are controlled by the stated company11. Contextually, if the company intending to transfer any assets have any distributable profits, under the Section 845 of Companies Act 2006, the transferor company is eligible to transfer assets at least equal to the book value of its distributable profits. Moreover, if the company transfers any asset at an amount less than the book value or at nil, in such cases the company is required to cover the deficit with distributable profits. In other circumstances, wherein the company intends to transfer assets but do not have distributable profits, the company’s directors are held responsible for unlawful return of capital. However, in certain cases it cannot be termed as unlawful, if directors make transfer of assets at considerations equal to the fair value of the transferred assets12. Practical Issues That Companies Need To Be Consider In Relation To Dividends As stated earlier, the aim of shareholders in setting up commercial corporate entity is primarily to make profits and share profits among them. Contextually, dividends are the part of company’s profit that is shared among the shareholders in proportional to numbers and the value of shares owned or in accordance to the agreement between the shareholders and the company13. It should be noted in this regard that companies can distribute dividends out of its net profit. Furthermore, the sizes of the dividends are mostly established during the general shareholders meeting that approves the information presented through updated balance sheets. Contextually, the prime condition that needs to be considered prior to the distribution of profits as dividends may consist the existence of substantial profits at the end of each tax year for annual financial statements14. It should be remembered as well that if there are no profits with the company at the end of the fiscal year, no distribution of dividends shall be made to its shareholders. At the same time, law does not make any restrictions to fully private companies in the distribution of net profits as depicted in the balance sheets. Hence, the private companies can fully distribute the profits as revealed in the balance sheets without any restrictions as per the policies briefed in its Association of Articles and Memorandum of Articles. On the other hand state owned companies do not enjoy the same liberty as in the case of private companies; further, in case of which, the distribution of dividends are regulated by government regulations15. There are certain consequences that companies may have to face in case of non-compliance with the rules and regulations stated in the Companies Act 2006 in the UK. Contextually, an unlawful dividend can be define as any distribution made by the company to its members that breaches the rules and regulations prescribed by Companies Act 2006 in relation to dividend distribution16. In case of breach of laws relating to dividend distribution is identified, shareholders are made liable to pay back the dividend to the company at any time when it was found that unlawful dividend distribution has been practiced, based on certain reasonable grounds17. It is important to understand that even a minor technical breach may lead towards unlawful dividends. The most common instances related with such case is non-availability of sufficient profits to make distribution and simultaneously when there is disbursement of interim dividends. Contextually, companies should avoid such practice of dividend disbursements in order to eliminate the consequences of unlawful dividends. Moreover, such actions can be attributed with companies’ failure to prepare relevant accounts prior to dividend disbursement due to lack of information concerning with the level of profit availability18. Hence, all the companies operating in the UK, whether private or publicly owned, it is necessary to abide by the rules and regulations that have been incorporated in the Companies Act 2006. Analysis of Dividend Law in UK Paying dividends is the usual way for the UK based companies to distribute a share of its profits among the shareholders. There are various statutory rules relevant to the distribution of dividends in Companies Act 2006, from sec. 829 to sec. 853. Usually, in a public company, the directors are responsible for declaring and paying an interim dividend based on the accounts for the initial six months of the company’s financial year19. Later, the director shall recommend the final dividend in annual general meeting based on the profit made during the year20. Consequently, in its annual general meeting, companies are required to pass a resolution relating to the payment of dividends. While in the case of private companies, practice varies to a large extent. Contextually, there are two ways for the disbursement of profits to the people who own and at the same time take the responsibilities of running the company21. In this relation, one such example can be referred as the directors who are paid salaries or fees for performing various duties in the interest of the company. Moreover, such salaries or fees are regarded as employment income and are further taxed under the PAYE system. On the other hand, shareholders, other than directors are paid according to the rights of the concerned shareholders. Dividends disbursed to shareholders are taxable as an investment income in the hand of respective shareholders. It is worth mentioning that tax rate of dividend income is lower than other sources of income22. There are various procedural steps that need to be met prior to the declaration of dividends in this context. In this relation, the company can pass ordinary resolutions and directors may decide to disburse interim dividends. However, it should be remembered that dividends should not be declared unless the company’s directors have recommended the amount to be distributed. Here, the prime consideration is that the dividend declared must not exceed the recommendations made by the directors. Furthermore, it is also necessary that no dividend shall be declared or paid without considering the rights of the shareholders. Moreover it is equally important to identify that if the company’s share capital is divided into various classes, no interim dividend shall be paid to those shares having differed or non-differed rights. Additionally, if at the disbursement time there exist arrears related with preferential dividends. Furthermore, directors are eligible to make payment at regular intervals at a fixed rate in certain circumstances when it appears that profits available within the company for making distributions of profits a justified the payment23. There are various options with respect to the distribution of profits to the shareholders where company’s capital is divided into shares. In this regard, dividend may transfer to a bank or as the directors otherwise decide. Furthermore, dividend can be paid in the form of cheques made payable to distribution recipients by post to the recipients’ registered address24. Contextually, the company is also not liable to pay interests on the dividends unless it is stated during the time of issuing shares and if there are any agreements between the shareholders and the company in terms of interest payable on dividends25. With respect to unclaimed dividends, the company can invest or directors can make use in the interest of the company until these dividends are claimed. Furthermore, it should also be noted that if twelve years or more has been passed since the declaration of dividends and had remained unclaimed all these years long, the company has the right to cease these unclaimed dividends26. Conclusion Decisions relating to the disbursement of dividends has been often regarded as crucial aspects of the companies based in the UK business environment, whether public companies or private companies. There are various rules and regulations that have been incorporated for protecting the interests of both shareholders as well as the company. Contextually, in UK, Part 23 of the Companies Act 2006 prescribes various provisions that need to be considered before making any kind of distribution to the shareholders. Furthermore, it is worth mentioning that provisions stated in the Part 23 of the Companies Act 2006 are applicable to all the companies in the UK maintaining their accounts either by following GAAP standards or with IFRS standards. Moreover, the Act identifies the directors’ role to be vital with respect to the disbursement of dividends to the shareholders. Accordingly, the companies in UK are required to make distribution exclusively through profit of the company and not through other modes. The distribution made to the shareholders is further required to be justified with relevant accounts. As far as the rules and regulations is concerned with distribution in private and public companies, it can be observed that public companies have to follow more rigid rules and regulations when compared to private companies. Both the companies, willing to make distribution, are liable to prepare interim as well as initial accounts depending on the case stated earlier. However, in the case of private companies there is no mandatory requirement for filing, while in the case of public companies, interim accounts and audited initial accounts need to be compulsorily filed with Companies house prior to the profit distribution27. Notably, there are several provisions that regulate various aspects related with the distribution of dividends which are required to be in compliance during the course of dividend distribution. Moreover, the non-compliance of this regulation shall also have certain consequences over the company including both directors and other shareholders. Hence, it can be stated that laws relating to distribution of dividends and profits in UK is relatively effectual to safeguard the interests of both the shareholders and the company to a great extent. References Association of Chartered Certified Accountants, ‘Shareholder Primacy in UK Corporate Law: An Exploration of the Rationale and Evidence’ [2011] (Research Report 125) accessed 07 January 2013. BDO LLP, ‘Companies Act 2006 Briefing’ [2010] (Distributions) accessed 07 January 2013. Bristows, ‘Companies Act 2006’ [2006] (Distribution of Profit and Assets) accessed 07 January 2013. 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Ozannes Mourant, ‘Directors' Concerns: Distributions and Dividends [2012] (Distributions and Dividends) accessed 07 January 2013. PricewaterhouseCoopers LLP, ‘response to dept of business’ [2008] (Response) accessed 07 January 2013. Sova & Partners, ‘Paying Dividends’ [No Date] (Notions and Regulations; General Rules) accessed 07 January 2013. The Institute of Chartered Accounts of Scotland, ‘Guidance on the Determination of Realised Profits and Losses in the Context of Distributions under the Companies Act 2006’ (2010) ICAEW Technical Release 1-168. The Ministry of Finance, ‘Report of the Steering Committee for Review of the Companies Act’ [2011] (Consultation Paper) accessed 07 January 2013. The Institute of Chartered Accounts of Scotland, ‘Technical Release’ (2009) Realised Profit 1-132. Slaughter & May, ‘Companies Act 2006- Practitioner Alert: distribution In Kind’ [2013] (Summary of Changes) accessed 07 January 2013. 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