PURCHASE OF OWN SHARES
Where a limited company is permitted to purchase its own shares it must either cancel them or sell them within 2 years
If the 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 balance sheet but should be deducted from 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 should not pay 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.
- A company may only make a distribution out of profits where ‘its accumulated realised profits are less its accumulated realised losses’.
- Any provision shall be treated as a realised loss except any provision in respect of a diminution in value in respect of all the non-current assets.
- If non-current assets have been revalued upwards and depreciation is provided thereon, then the excess of this depreciation over depreciation on cost can be added back notionally to the income statement for the determination of realised profits.
- On the disposal of a revalued asset any surplus held in reserves becomes realised.
- IAS 21 requires recognition of gains or losses on foreign currency transactions as part of the profit or loss for the year. Such items should normally be treated as realised except gains on unsettled long-term monetary items.
- Distributing group profits means distributing from the individual accounts of the holding company. Profits of subsidiaries or associates would only be considered as realised when dividends have been declared and are receivable by the holding company.
- Development expenditure carried forward in the balance sheet which fulfils the IAS 38 criteria.
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.