Government plans overhaul of dividend framework

The government is considering whether to reinforce the rules on dividend payouts and distributions to give stronger reassurances to shareholders and prevent dividends from undermining the viability of a company, reports James Bunney

The government has confirmed that it will undertake a further review of dividend treatment following the insolvency and corporate governance consultation, conducted by the Department for Business, Energy & Industrial Strategy (BEIS). It has made it clear that it is considering changes to the current framework following an extensive consultation involving industry leaders.

Respondents to the call for evidence included ICAEW, EY, KPMG, the Institute of Directors (IoD) and the British Chambers of Commerce (BCC).

According to the report, ‘the consultation sought views on whether the UK’s current regime based on the concept of “distributable profits” remains fit for purpose. This was in the context of examples of companies in apparent financial difficulties and approaching insolvency, nonetheless continuing to pay significant dividends.’

Companies have in the past paid dividends even when in a difficult financial position. Capital allocation decisions have been particularly criticised for their lack of transparency, and information about the affordability of dividends in relation to liabilities has sometimes been lacking. 

This has been illustrated by recent events. Notably, construction firm Carillion paid dividends to shareholders even after the funding hole in its pension scheme was revealed, further increasing the size of its debt before it collapsed.

In the consultation response document, the government said that it has asked ICAEW and the Law Society to examine the reform proposals and report their findings to the government, but no timetable for possible legislative changes has yet been issued. 

Current framework

At present, dividends can only be paid out of profits available for distribution as shown in the relevant accounts drawn up in accordance with applicable UK law and accounting standards. Dividends cannot be paid out of capital but only from accumulated realised profits less accumulated realised losses.

A significant proportion of respondents felt that reform was necessary for, as the report notes, ICAEW guidance on the interpretation of this requirement currently runs to 170 pages. Lawyers and financiers, according to the responses generated, were particularly concerned that ‘that a system based on capital maintenance is, in practice, largely ineffective in protecting creditors’.

A number of those canvassed argued that companies 'should be required to disclose the audited figure for available reserves and distributable profits in their annual report and accounts'. Still others suggested that the UK could implement an approach used in the US and Australia, under which dividends are only paid when the board is satisfied with solvency statements by directors.

The significance of dividend payments to the future health of a company was seen by many respondents as paramount, as capital allocation decisions play a significant role in a company’s long-term success, fostering investor engagement with boards and company-wide decisions.

Greater transparency in this area would, according to some, allow shareholders to see - and have a say on - how surplus revenue is allocated to research and development, pension deficits, and dividends, as well as the managerial attitudes that inform those decisions.

The example of Carillion also prompted several respondents to express the opinion that there ‘should be more transparency and stronger regulatory oversight of dividend payments where there is a substantial pension fund deficit. One respondent suggested that The Pensions Regulator should have enhanced powers to satisfy itself that, where there is a material scheme deficit, the payment of dividends or the sale of the company will not jeopardise the solvency of the fund.’

Moving forward

Confronted with the extent of the responses, BEIS has committed to moving forward with amendments to the existing framework.

The report stated that the government 'is also concerned about the practice of companies avoiding an annual shareholder vote on dividends by only declaring interim dividends and has asked the Investment Association to report on the prevalence of the practice', adding that it would 'take further steps to ensure that shareholders have an annual say on dividends if the practice is widespread and investor pressure proves insufficient'.

Options that it would consider ‘include a requirement for companies to disclose the audited figure for available reserves and distributable profits in their annual report and accounts and ways in which the definition of “net assets” might be tightened such as a more critical look at the valuation of “goodwill”.’

Calculating profits

Assessing dividend payments would be made more complex by these proposals. Anne Cowley ACA, senior technical writer for Croner-i Tax and Accounting said ‘it would take time to get an auditable figure for distributed reserves quickly - it would take at least two to three years to get comparables’.

'Although some of the measures sounded reasonable, it would be very difficult in practice, and there could be an increase in qualified audit reports if this were to be implemented,' Cowley added. 'When companies and their auditors disagreed on the treatment of legacy reserves and even the purposes of historic reserves, this would lead to lots of reserves restatements.'

Responding to the government proposals, Roger Barker, head of corporate governance at the IoD, said: ‘There are a number of issues around calculating distributable profits. The report mentioned challenges in accounting for revenue and goodwill- this was an issue in the Carillion case. There is a need for the accounting profession to renew its efforts to make sure the rules are tightened up in this area.

‘The government has said that it is not planning to restrict dividend payments currently. We would not want to see appropriately calculated distributable profits being restricted but the proposal that we have put forward is that in certain sectors, such as companies that are involved in providing public services, the idea of a new legal form for a company: the public services corporation. In this part of the legal duties of the board of directors, they would balance the allocation of surpluses generated between dividends, pension fund payments and other areas.

‘We do want to see more work done on the accounting for dividend payments but to impose direct control over dividend payments would be a step too far.’

The Law Society has previously stated that it believes that ‘the ability of companies to pay dividends is a key element in the investment case for equities and both boards of companies and investors would benefit from having a clear and coherent regime that encourages the appropriate payment of dividends’.

A spokesperson for the Law Society said: ‘We believe a review of the dividend regime is merited. A lack of clarity has led to disagreements about how the law operates and we are pleased the government is looking to engage further with stakeholders to resolve these outstanding issues.’

ICAEW declined to comment.

Insolvency and corporate governance: government response, published 26 August 2018, is here 

Report by James Bunney

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