PURCHASE OF OWN SHARES
If purchased shares are cancelled, the purchase must be financed by a fresh issue of shares, thus ensuring that share capital is maintained, or by the transfer from distributable profits to a capital redemption reserve fund or a sum equal to the nominal value of the shares purchased. As the fund is not distributable, the profit is effectively frozen, thereby ensuring that permanent capital is maintained intact.
If the shares are purchased at a premium and then cancelled, the premium must, in general, be paid out of distributable profits. This ensures that the share premium account, which is part of permanent capital, is not reduced. But where the purchased shares had been issued at a premium, the premium on purchase of the shares may be made out of a fresh issue made to finance the purchase. However, this may only be done up to the aggregate of all the premiums received on the original issue of the shares or the present balance of the share premium account, whichever is the lower.
Where a company purchases shares and holds them as treasury shares, the cost of the shares must be met out of distributable profits. There is no requirement to create a capital redemption reserve fund since the issued share capital has not been reduced. The cost of the purchased shares should not be shown as an asset in the company’s Statement of Financial Position but should be deducted from distributable profits.
Advantages of purchase of its own shares by a limited company include:
- It is usually difficult to sell shares in a private company.
- Dissident shareholders may be bought out in a relatively easy way.
- It may enable a company to return surplus funds to the shareholders.
- It may enable a family to retain control of a company.
- If purchased shares are held as treasury shares, they may be re-issued. This could enable a company to buy in and re-issue shares under an employees’ share scheme.
Disadvantages include:
- Compliance with legal requirements could freeze revenue reserves thereby reducing the funds available for dividends.
- The purchase might give rise to liquidity problems.
- Majority shareholders may end up with full control of the company as minority shareholders are bought out.
DISTRIBUTABLE PROFITS
A distribution is defined as every description of distribution of a company’s assets to members (shareholders) of the company whether in cash or otherwise, with the exception of:
- An issue of bonus shares
- The redemption or purchase of the company’s own shares out of capital (including the proceeds of a new issue) or out of unrealised profits
- The reduction of share capital by: o Reducing the liability on shares in respect of share capital not fully paid up o Paying off paid-up share capital
- A distribution of assets to shareholders in a winding up of the company
All companies are prohibited from paying dividends except out of profits available for that purpose. The general approach is that distributable profits consist of accumulated realised profits less accumulated realised losses.
Additional Rules for Public Companies
A public company may not pay a dividend unless its net assets are at least equal to the aggregate amount of its called up share capital and undistributable reserves.
Undistributable reserves are:
- Share premium account
- Capital redemption reserve fund
- Unrealised profits less unrealised losses
- Any other reserve which the company is prohibited from distributing by any statute or by its Memorandum or Articles of Association.
