NOTE: This article has been updated and includes more detail as at November 2015. The comments refer to the 2012 article.
Companies often need to adjust their shareholdings and capital structures to cope with a variety of situations. Jennifer Adams provides step-by-step guidance on the main procedures.
Most private companies start their lives by issuing a nominal number of shares of a nominal value. As firms grow and evolve, the number of shares may need to be increased.
Reasons for increase:
- To generate more capital - See 'Rights Issue of shares'.
- To reflect the correct position of the company’s balance sheet; bonus issues are used when a company has excess profits that need to be retained for future use rather than distributed as dividends.
- Private companies sometimes issue bonus shares in conjunction with rights issues. With a straight bonus issue the ratio of the number of shares held by each shareholder remains, unlike a rights issue, where the investment is reduced. Issuing bonus shares with a rights issue can be a way of increasing the holding of those shareholders who do not or cannot take advantage of the rights issue.
Bonus share issuing procedure
The legal procedure for a Bonus issue is similar to a Rights Issue.
In summary:
- Check Articles to confirm that the directors are authorised to issue bonus shares and the procedure, if stated (Model Article No 36 requires authority via an ordinary resolution)
- Issue relevant share certificates - within two months of passing of resolution
- Submit form SH01 (Return of Allotment of Shares) to Companies House (CH) within 15 days of allotment
- Update Register of Members.
Reasons for reduction
- Errors - in an Answers post Reduction in share capital or share buyback, charlb cited a situation where an error has been made (e.g. the intention on incorporation was to issue just 1 x £1 share, but 10,000 x £1 were stated by mistake. If it can be proved that the intention was for one share and the balance has not been paid, then backed by documentary evidence CH and HMRC usually correct the error and nothing further needs to be done. Evidence is key however, should the authorities not be persuaded, Steve Kesby suggests another method: “If the whole of the share capital were to remain unpaid, you could redenominate it into smaller amounts and then call it all up on terms that mean that any shares that remained unpaid would be forfeited, other than subscriber shares.” Otherwise the reduction needs to be via the solvency statement route (see further).
- Specific reasons - The reduction in share capital creates a realised profit reserve (s654 CA2006), so companies frequently undertake reductions to create and/or increase distributable reserves, or reduce accumulated losses. Specific reasons might be to:
- eliminate a deficit on the company’s profit and loss account, enabling the company to pay dividends
- pay value to shareholders where the company does not have sufficient distributable reserves to pay a cash dividend
- eliminate historic accumulated losses, which may be preventing the payment of dividends
- return surplus capital to shareholders
- distribute assets to shareholders, possibly including surplus cash if a dividend is then subsequently declared
- redeem outstanding shares (uncalled capital) or complete a share buyback where there are insufficient distributable reserves
- convert share capital into loan capital.
Reducing share capital procedure
- Review companies Articles and other relevant documents
In the past, it was only possible to carry out a reduction by going to court, however CA 2006 Chpt 10 now a 'simplified procedure' permits a private company to reduce by special resolution if there is nothing in the company’s Articles to prevent the procedure. Other documents to review include banking facilities and shareholders agreement of present.
- Prepare insolvency agreement
Reserves are not needed but each director must sign a solvency statement confirming their view that the company is solvent and will remain so as the debts fall due within the following 12 months. Should it be intended for the company to be wound up within that period all directors must sign to confirm that the debts will be paid within 12 months of the commencement of the winding up process. (Co Act 2006 s643)
This statement procedure was introduced to simplify matters and make it less costly for private companies, but a company can still apply via court order if it wishes - this would be the route if any director were unable or unwilling to sign or if the company wished to reduce its capital to zero. (CA 2006 s645).
- Check insurance arrangements
Should directors have insurance they should check to see whether the policy covers the cost of defending proceedings.
Companies House requirements
Within 15 days of passing the special resolution (by a majority of not less than 75% of the voted) the following must be submitted (CA 2006 s644):
- Two copies of the special resolution and solvency statement
- Written confirmation by the directors that the statement has been sent to all shareholder/members
- Revised statement of capital on form SH19; and
- A fee of £10.
- Statement of compliance signed by all directors confirming that the solvency statement was made not more than 15 days before the date of the resolution.
HMRC's view
If a distributable reserve is created HMRC's view is that 'Any payment out of reserve of this type will be a distribution under s1000 (1) B and as it is treated as made out of distributable profits, no part of it will be treated as representing a payment out of capital on the sales. The distribution will therefore be chargeable to income tax.' Where no distributable reserve is created it is not chargeable to income tax but may be charged as a capital distribution under s122 TCGA 1992. (see CTM 15440)
Final points
- The company must have at least share remaining under the “solvency statement” method and this cannot be reduced to leave the company with only redeemable shares.
- If the solvency statement has not been issued to each shareholder both the company and its individual directors are in default and liable to a fine.
- If the statement is proved to be incorrect it is more serious matter and can result in imprisonment (and/or fine) for each director.
- Creditors can only object in a court supported reduction.
- The reduction does not take effect until the documents are registered at Companies House rather than just being delivered.
- The special resolution must spell out the process for the reduction as the accounting entries will follow the wording.
Jennifer Adams FCIS TEP ATT (Fellow) is Associate Editor at AccountingWEB. A professional business author specialising in corporate governance and taxation, she has written for many of the leading specialist providers of legal, tax and regulatory publications. Jennifer runs her own accounting and consultancy business with offices based in Surrey and Dorset.
