On 3 November 2010, the Institute of Chartered Accountants in England and Wales and the Institute of Chartered Accountants in Scotland published a revised joint guidance (TECH 02/10) on the determination of realised profits and losses for the purposes of making distributions under the Companies Act 2006 (the Act).
Under Part 23 (Distributions) of the Act, a company's distributable profits are its accumulated realised profits so far as not previously distributed or capitalised) less its accumulated realised losses (so far as not previously written off in a reduction or reorganisation of its share capital). The extent to which profits or losses fall to be treated as "realised" for these purposes is principally determined in accordance with generally accepted accounting principles.
TECH 02/10 provides guidance on these principles and replaces the previous guidance issued in June 2009 (TECH 01/09), which was itself updated for additional guidance issued in draft form in January 2010 (TECH 03/09).
The main changes which have been made to TECH 01/09 include the following:
Linked transactions (and cash box structures) - Where a company enters into a number of transactions that are linked, those transactions need to be looked at together in order to assess whether any which profit arises from them is realised. Additional guidance has been provided as to when transactions will be linked for these purposes. In particular, specific guidance has been included as to when a reserve that arises on the issue of shares by a company which is undertaking a placing using a cash box structure will be a realised profit.
Reductions of acquired liabilities - Any profit arising on the reduction of an acquired liability will only be realised when that profit is readily convertible to cash.
Cash dividends settled by set off - Where a parent company owes a receivable to its subsidiary (i.e. a so-called "upside down" intra-group loan), all or part of that receivable constitutes an unrealised profit in the accounts of the subsidiary, and the subsidiary wishes to pay a cash dividend equal to the amount of the unrealised profit, the subsidiary can treat the unrealised profit (up to the amount of the dividend) as realised for these purposes. This is however only permissible where the cash dividend is then set off against the receivable (and not actually paid to the parent).
Distributions in kind of fungible assets - Where a company wishes to distribute an asset in kind (rather than pay a cash dividend), and all or part of the value of that asset stated in its accounts represents an unrealised profit, section 846 of the Act allows the amount of that unrealised profit to be treated as realised for the purposes of the distribution. Where the unrealised profit relates to fungible assets (such as shares or loan notes) and not all of those assets are to be distributed, the unrealised profit must be applied pro rata to the assets to be distributed to determine how much of it can be treated as realised for the purposes of the distribution.
View TECH 02/10 (168 page pdf).