The ICAEW has published TECH 02/17 which provides updated guidance on realised and distributable profits under the Companies Act 2006. TECH 02/17 is based on TECH 02/16, which it replaces, and on TECH 05/16 which was issued for comment last year.
The release represents generally accepted practice as at 31 December 2016 in relation to the meaning of realised profits and will not affect the legality of distributions already made out of realised profits which have been determined by reference to accounts prepared in accordance with prior accepted practice. The release does, however, make changes to the explanation of what constitutes a distribution which are based on legal advice rather than representing generally accepted practice. (We discuss one such change below.) In that case the changes are relevant to historic distributions as well as future ones - it is possible that transactions which, based on TECH 10/02, would not have been viewed as distributions should in fact have been regarded as such and may have been unlawful in the absence of adequate distributable profits.
The release does not make any fundamental changes in relation to realised and distributable profits, but there are two points in particular to be aware of:
- the release states that a distribution can also arise where a subsidiary guarantees a liability of its parent or of a fellow subsidiary if the subsidiary giving the guarantee does not receive a market rate fee in return – as noted above this is a legal point so applies not only to guarantees given in the future but also to historic guarantees. The fact that a guarantee may involve an unlawful distribution should not affect the validity of the guarantee itself; in our view this should merely mean that the parent/fellow subsidiary is liable to pay to the guarantor an amount equal to the market rate fee.
- the release states that an intra-group transaction may involve an unlawful distribution by a company which is not actually a party to that transaction. The example given is where a subsidiary (Company C) transfers an asset to its ultimate parent (Company A) at an undervalue. This may not be an issue for Company C if it has sufficient realised profits, but may involve an unlawful distribution by the intermediate holding company (Company B) sitting between Company A and Company C in the chain of ownership if Company B does not have sufficient realised profits to cover the reduction in value of its investment in Company C. The release appears to state that a distribution will only arise if Company B knows of the proposed transaction and does not take steps to prevent it. It appears strange both that a company can make a distribution without doing anything at all and that the state of mind of its directors (which may be difficult to establish) can be the determining factor in whether there is a distribution or not. For the time being, though, great care should be taken if anyone is implementing transactions of this type.
TECH 02/17 can be found here.