Reductions of capital: What are they and what can they be used for?

We consider reductions of capital under the Companies Act 2006, looking at why they might be used and the benefits they can bring.

What is a reduction of capital?

Generally speaking, a company is prohibited from returning share capital to shareholders even if that share capital is surplus to the company's requirements. There are, however, exceptions to this rule. One such exception is a reduction of capital in accordance with the procedures set out in the Companies Act 2006.

Why might a company want to reduce its share capital?

A company might want to reduce its share capital to:

Creation of distributable reserves

This is possibly the main reason that companies reduce their capital.

A reserve arising from a reduction of capital is generally treated as realised profit. A capital reduction can therefore:

  1. Increase existing distributable reserves (perhaps to facilitate a dividend payment).
  2. Reduce or eliminate accumulated realised losses (which may prevent a company paying a dividend even where it is trading profitably).
  3. Eliminate accumulated realised losses and leave the company with distributable reserves.

Return of surplus capital

A capital reduction can be used to release a liability to pay up unpaid share capital.

A reduction can also be used to repay paid up share capital. If this is done by a direct payment to the shareholders it does not result in the creation of a reserve. This is particularly useful as a means of getting money to shareholders where the company has accumulated losses. For example, if a company with accumulated losses of £100 carried out a reduction of capital of £300 with a reserve being created in respect of the reduction, this would only allow a subsequent distribution of £200 by way of dividend. However, if a reserve is not created and the capital is repaid directly to the shareholders, the full £300 can be repaid regardless of the accumulated losses.

Facilitate a buyback or redemption of shares

In the following circumstances, a reduction of capital may improve the company’s distributable reserves in order to facilitate a buyback or redemption of shares:

  1. Where a company has insufficient distributable reserves to fund a buyback or redemption.
  2. Where there are no new shares being issued which might otherwise fund the buyback or redemption.
  3. Where a private company does not have plans to buyback or redeem shares out of capital.

Distribution of assets to shareholders

A reduction of capital can also be used to transfer a company’s assets to its shareholders, for example, by reducing the nominal value of shares and distributing assets in return.

How can a company reduce its share capital?

Broadly speaking, a company can reduce its share capital:

  1. By special resolution confirmed by the Court (available to both public and private companies).
  2. By special resolution supported by a solvency statement (available to private companies only).

The solvency statement procedure is the method most often used by private limited companies as it is usually much simpler. However, it does involve the directors signing a statement relating to the solvency of the company. The decision to sign the solvency statement should not be taken lightly. If the directors make the statement without having reasonable grounds for the opinions within it, they will be committing an offence potentially punishable with imprisonment.

For more information on reductions of capital, please contact a member of the team below.

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.