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Distributable Profits Guidance

By Julia Penny

The ICAEW has recently issued a factsheet on distributable profits to help support the updated full guidance contained in TECH 02/17BL.

The guidance is important because the issue of what is, or is not, distributable becomes much more complex under FRS 102 than under old UK GAAP.

Many of you may remember some of the basic principles, including the ability under s.845 to distribute an asset at book value (rather than fair value) as long as the transferor has at least £1 of distributable profits. An example of where this may be an issue is with the transfer of tax losses between group companies for a non-arm length sum. In the absence of distributable reserves, this may be an unlawful distribution.

Confusingly, it doesn’t matter if a distribution is labelled as such in the accounts. The payment of a preference dividend will often be accounted for as interest payable, but it is legally a distribution, so requiring the presence of sufficient distributable profit.

One example of this type of situation was highlighted a few years ago in relation to trading charities passing their profits up to their parent charity under gift aid. Such payments will generally meet the definition of a distribution and will therefore only be legal where there are sufficient distributable profits available. Further guidance on this is given in ICAEW TECH 16/14.

Looking more specifically at what profits are available for distribution the Companies Act states that they are the accumulated realised profits (so far as not distributed or capitalised) less the accumulated realised losses (so far as not previously written off in a reduction or reorganisation of capital). This doesn’t sound too complicated, but it gets worse. Realised profits and losses are “such profits or losses as fall to be treated as realised in accordance with principles generally accepted at the time when the accounts are prepared, with respect to the determination for accounting purposes of realised profits or losses”. So, what is realised, depends on what is regarded as realised at the time!

This somewhat challenging state of affairs has arisen because at the time the law was written only realised profits were included in the profit or loss account. Therefore, it was straightforward to determine what those were with reference to GAAP at the time. Now, of course and particularly with the advent of FRS 102, there are a number of areas where this is not the case.

Profits are only treated as realised when they have been turned into cash or other assets the ultimate cash realisation of which can be assessed with reasonable certainty. So for fair value adjustments, whether they are realised or not depends on the situation. Listed shares, for instance, can be turned into cash at the balance sheet date by ringing a broker and asking them to sell the shares. The gains are therefore treated as realised, as they could have been easily turned into cash at the balance sheet fair value.

An investment property fair value gain though, cannot easily be turned into cash and so there isn’t that reasonable certainty, as you may or may not be able to sell the asset at that price. Such a gain is not realised.

For derivatives, some can be traded easily, so gains would be realised, whereas others are not traded and could not be turned readily into cash and are therefore unrealised.

All of this is pointing to an environment in which you need to be careful (or advise the directors of your clients to be careful) to identify what is and what is not, realised when making a decision on distributions.

The factsheet contains useful examples and explanations, together with cross references to other legislation and guidance. It is likely to be the best place to refer to in the first instance, when trying to understand a distributions issue. However, if more guidance is needed you will find yourself going back to the much more detailed TECH 02/17BL release, company law and potentially even seeking legal advice.  

September 2017 


This article is published with the understanding that SWAT UK Limited is not engaged in rendering legal or professional services. The material contained in this article neither purports, nor is intended to be, advice on any particular matter. This article is an aid and cannot be expected to replace professional judgment. SWAT UK accepts no responsibility or liability to any person in respect of anything done or omitted to be done by any such person in reliance, whether sole or partial, upon the whole or any part of the contents of this article.