Owner-managed companies can now reduce their share capital with relative ease. Following CA 2006, Pt 1, Ch 10, the legal process for a reduction of share capital is fairly simple, and no longer requires the expense of seeking court approval. These ‘capital reduction’ rules can be used to assist owner-managed companies in various ways, including:
- to create distributable reserves (often by removing a deficit on reserves) so as to enable a legally valid dividend to be paid;
- to remove so-called ‘dividend blocks’ within a corporate group, where dividends cannot be paid up to the parent company because an intermediate group company has a substantial deficit on its reserves;
- to effect a corporate reconstruction or demerger of an investment business without having to liquidate a company under an Insolvency Act 1986, s 110 scheme; and
- to return property assets to the shareholders (for example, to avoid the annual tax on enveloped dwellings), particularly where the property was originally transferred to a company in consideration for shares.
Practical applications
Some companies have relatively small amounts of issued share capital and may feel that these capital reduction techniques may not apply to them. However, the ability to reduce capital goes beyond the nominal value of issued share capital to include share premium account and capital redemption reserves.
Whilst it is not permissible to apply a property revaluation reserve as part of a capital reduction exercise, the same results can be achieved by first using the revaluation reserve to issue fully paid-up bonus shares equal to the capitalised amount. Having created the ‘additional’ share capital, this can then be reduced in accordance with the CA 2006 provisions.
Many corporate demergers are now structured using return of capital techniques to implement the relevant demerger of the business or businesses. In many cases, there will be a preparatory transaction to create the relevant share capital. This is typically achieved through an initial share for share exchange transaction, which entails a new holding company (Newco) being inserted above the existing company or group. Under this transaction, the selling shareholders of the original company will effectively subscribe for their Newco shares for an amount equal to the market value of their original shares. This does not affect the ‘new for old’ treatment that applies for capital gains tax (CGT) purposes (under TCGA 1992, ss 127 and s135) – the so-called CGT ‘no disposal fiction’. The issue of the new consideration shares will create the necessary ‘share capital’ out of which a subsequent demerger distribution can be made.
Legal procedure
A share capital reduction requires a special resolution made by the shareholders (which may be in the form of a written resolution).
Briefly, within the 15-day period before the resolution, the directors must support the capital reduction by providing a solvency statement complying with CA 2006, s 643. The solvency statement, which must be approved by each director, confirms that:
- there are no grounds for the company being unable to pay its debts; and
- that any winding-up of the company within 12 months would be a solvent liquidation.
There is no requirement for a supporting statement from the company’s auditors.
After the special resolution is passed, the company must send to the Registrar of Companies (within 15 days of the resolution):
- a copy of the special resolution;
- the solvency statement; and
- a statement of capital.
The statement of capital reflects details of the company’s share capital after the reduction has been undertaken.
Practical Tip:
A reduction of share capital may enable a company to pay legally compliant dividends, subject to the directors’ fiduciary duties to act in the company’s best interests and those of its creditors and potential creditors.
