Whilst there may be a variety of reasons why a company would reduce its capital (for e.g. to increase the future earnings per share, to reward the shareholders in cash etc), the biggest attraction of all remains that a capital reduction could create a reserve that can be distributed as a realised profit. This article deals with the law and procedure for reducing of capital by private companies.
Company law considerations
Capital reduction could be achieved by a) extinguishing or reducing the liability on any of its shares not paid up or b) by cancelling any paid up capital or repaying back any unwanted paid-up capital. Chapter 10 of part 17 of the Companies Act 2006 deals with reduction of capital. S. 641(2) prohibits a company from reducing its capital if it would result in there being no shares other than redeemable shares. That said the company law procedure is fairly straight forward, although it involves some paper work.
a) Pass a special resolution supported by a solvency statement by the directors: If it is a written resolution a copy of the solvency statement should be sent to each eligible member or where a general meeting is held a copy of the solvency statement should be available for inspection.
b) Solvency statement (s.643): This contains an opinion signed by all the directors that:
- there is no ground on which the company could be found to be unable to pay its debts as at the date of the statement, and
- if a wind up is intended to take place in the next 12 months, then the company will be able to pay its debts in full within 12 months of commencement of the winding up or if there is no wind up coming up in the next 12 months, then the company will be able to pay its debts as they fall due in the year immediately following the date of the statement.
The solvency statement should be prepared within 15 days before the special resolution and be signed by all the directors with their names and the date stated on it. In preparing the statement the directors should consider the financial position of the company, particularly its ability to pay all the debts, within the next 12 months. For this reason it is advisable that suitable financial projections are made using all available information. In forming their opinions, the directors must take in to account the company’s current, contingent and prospective liabilities. If the directors make a solvency statement without having reasonable grounds for the opinions in it, every director in default commits an offence which on conviction may even lead to imprisonment.
c) Filing documents with the companies house:
The company should file the following with the Registrar within 15 days from the date of the special resolution:
- The special resolution
- The solvency statement,
- Statement of capital (form SH19)
- A compliance statement by the directors confirming that the solvency statement was made not more than 15 days before date of the special resolution and that a copy of which was provided to all eligible members.
The special resolution takes effect when these documents are registered by the Registrar (s. 644(4) which should be done within 15 days.
Treatment of reserves
S. 3(2) of the Companies (Reduction of Share Capital) Order 2008 provides that where a private company limited by shares reduces its share capital and the reduction is supported by a solvency statement but has not been the subject of an application to the court for an order confirming it then the reserve arising from the reduction is to be treated as distributable as a realised profit.
Tax considerations
According to section 383 of the ITTOIA 2005 distributions received by individuals and non-corporate shareholders are charged to income tax. S. 989 of ITA 2007 defines distribution to mean the same as that provided under section 1000 of the CTA 2010 which includes capital dividend also within the definition of distribution. A payment which is a repayment of share capital (including share premium – s 1025 CTA 2010) following a capital reduction exercise is not distribution and should not be charged to income tax and should be charged under s 122 TCGA1992, as a capital distribution. If, however, share capital (including premium) is reduced and a reserve is created as a realised profit before distribution, such distributions will be taxed as income. Therefore, to ensure a capital gains tax treatment it must be ensured that the payment is a clear return of capital. Oddly, therefore, the accounting treatment will assume considerable significance when it comes to taxation of repayments upon capital reduction. The key to a capital gain treatment is that the capital reduction should be followed by cash leaving the company and the capital getting reduced without touching the reserves!
