Earlier this year, the government’s Department of Business, Energy and Industrial Strategy (BEIS) published its public consultation paper ‘Restoring Trust in audit and corporate governance’ aimed at improving the UK’s audit, corporate reporting and corporate governance systems. The comment period for the consultation is now over and the government is going through the responses.
The paper included proposals to require companies to report on their distributable reserves and for directors to be required to make a formal statement about the legality and affordability of proposed dividends.
In the table below we summarise the main current issues relating to distributable reserves and what has been proposed by BEIS. In light of this, we then set out what we believe are the actions management should take now to ready themselves and their organisations for greater disclosure and accountability in relation to distributable reserves.
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- There is no fixed definition of realised profits and losses. The Companies Act definition refers to ‘principles accepted at the time’. The current practice is to follow the joint guidance issued by ICAEW and ICAS “Tech 02/17 – Guidance on Realised and Distributable Profits”.
- There is a transparency issue. There is no legal requirement to disclose profits available for distribution. FRC encourages disclosures of profits available for distribution but it has not been mandated.
- The law’s focus on capital maintenance and realised profits and distributable reserves is backward looking – the current requirements do not explicitly include considering the future performance of the company or its future financial requirements when paying dividends.
Proposals
- Assign responsibility for defining realised profits and losses to the Audit, Reporting and Governance Authority (ARGA) -FRC’s successor body, and enhancing the legal status and enforceability of the definition.
This would provide the guidance on determining profits available for distribution with a legal status and an opportunity to ARGA to revisit the ‘realisation test’ i.e. what is considered as profits available for distribution - i) Disclose the distributable reserves in financial statements of parent company
ii) Disclose an estimate of a group’s dividend paying capacity supported by narrative disclosures to explain major constraints - Confirmation that it is the directors’ reasonable expectation that payment of the dividend will not threaten the solvency of the company over the next two years. Requirement for fuller narrative explaining a company’s distribution policy and general approach to capital maintenance.
So with the inexorable move towards greater disclosure and accountability in relation to distributable reserves and the distribution of those reserves, what are the actions that we believe management should consider now?
Ten ‘no-regrets’ actions
Whilst the proposals are at a consultation phase and the new law is not expected to be in force for another 6-12 months, below are some of the actions (if not already in place) that could be considered by businesses to get ahead of any new requirements: :
- Draft a dividend and capital maintenance policy considering requirements to service external debt and investor’s expectations.
- Perform a distributable reserves review of the ultimate parent company (if a UK incorporated parent) in the group and keep it up to date at each period end.
- Identify the key cash generating legal entities within the group which contribute towards payment to dividend to ultimate shareholders.
- Consult with shareholders on the level of detail expected by them on disclosure of estimated reserves of the group.
- Discuss the impact of narrative and quantitative disclosures on distributable reserves with all relevant internal stakeholders.
- Consider obtaining external assurance on the potential computations/disclosures.
- Clear dividend blocks within the current rules, if feasible.
- Discuss any requirements from directors for satisfying them about enhanced focus on s172(1) disclosures along with the new reasonable expectation of solvency for 2 years post payment of dividend.
- Discuss the impact on professional indemnity insurance for directors of the potential changes.
- Closely follow the response from the government on the consultation on the BEIS recommendations.
BEIS is currently considering the responses to the consultation and we do not yet know what the final requirements will look like. However, the ‘no-regrets’ actions listed above should give you a good head-start in preparing for what changes are enacted. Clearly, the extent of any actions undertaken will depend on the size and complexity of the organisation and its reserves “history”, but now is the time to start thinking about the potential implications of the new regime for your business.
