The Institute of Chartered Accountants in England and Wales and the Institute of Chartered Accountants of Scotland published TECH XX/16 this week, an exposure draft on updated guidance on realised and distributable profits under the Companies Act 2006.

The purpose of the guidance is to identify, interpret and apply the principles relating to the determination of realised profits and losses for the purposes of making distributions under the CA 2006. TECH XX/16 is based on TECH 02/10, published on 3 November 2010, and has been marked up to show the proposed amendments.

Since TECH 02/10 was issued, there have been changes to IFRS and also to the UK accounting standards. The principles set out in TECH 02/10 apply to the revised financial reporting requirements which do not raise any fundamentally new issues for realised and distributable profits. However, the ICAEW considers that it is appropriate to refresh the guidance and update references as necessary, as well as addressing certain new issues which have been identified.

Draft guidance

As well as updating references to accounting standards and removing obsolete material, the following main changes are proposed:

  1. additional guidance has been added concerning the definition of a distribution and the interpretation to be taken from section 829 of the CA 2006, which has been applied to certain intragroup off-market loans. The guidance notes that although the definition of a distribution refers to distributions of assets, a distribution can arise from an assumption of a liability if the company does not receive consideration of the same amount. This is because the liability commits the company to transfer assets at a future date and its assets are therefore reduced when entering into the commitment. This draft guidance has immediate effect;
  2. additional guidance has been added to address the consequences of accounting for intragroup off-market loans, which are recognised initially at fair value rather than face value. The guidance addresses the nature of the difference in value and subsequent interest income and expense under the law and for distributable profits. The guidance also sets out the accounting treatment for an interest free loan from parent to subsidiary, subsidiary to parent and subsidiary to fellow subsidiary;
  3. additional guidance on the meaning of distributions in kind. Sections 845 and 846 of the CA 2006 provide for a distribution consisting of or including, or treated as arising in consequence of the sale, transfer or other disposition by the company of a non-cash asset (a distribution in kind). The guidance now refers to section 1163 of the CA 2006 on the definition of non-cash assets which states, among other things, that a reference to the transfer or acquisition of a non-cash asset includes the discharge of a liability of any person, other than a liability for a liquidated sum. Therefore, the guidance proposes that a distribution that arises from the discharge of a liability for a liquidated sum is not within the scope of a distribution in kind under sections 845 and 846 of the CA 2006. A waiver of an amount from a parent is a distribution but not a distribution in kind under sections 845 and 846. This draft guidance also has immediate effect;
  4. additional guidance on the determination of the amount of a distribution in kind. In determining whether a company has profits available for distribution after any adjustment in accordance with section 845(3) of the CA 2006, it is concluded that there must always be a positive balance of profits available for distribution, however small, immediately before the transfer of the asset and the balance cannot be nil. However, the guidance now notes that the balance may be nil after the transfer of the asset when the asset is transferred at below book value such as to eliminate the whole of the positive balance. This draft guidance has immediate effect;
  5. the section on deferred tax has been reorganised and clarifies that, unless it is the reversal of a realised loss, a deferred tax credit which results in the recognition of a deferred tax asset will generally be an unrealised profit, because a deferred tax asset does not usually meet the definition of qualifying consideration;
  6. exchange of assets or "top-slicing"; top-slicing is used to describe a situation where an asset is sold partly for qualifying consideration and partly for other consideration (for example a mixture of cash and real property) and any profit arising is a realised profit to the extent that the fair value of the consideration received is in the form of qualifying consideration. The guidance notes that to apply the top-slicing rule in a hive down or hive across, any liabilities should first be deducted from the amount of qualifying consideration received; and
  7. the guidance on retirement benefit schemes has been rewritten on a simplified basis.

 Comments on the exposure draft are invited by 9 June 2016.