Which equity items may be distributed to shareholders? #3

Equity comprises several distinct accounting items, each having a different economic origin and legal treatment. Within equity, profit and other own resources may be distributed to shareholders, provided that the relevant item is not restricted by law or by the company’s constitutional document.

A proper assessment therefore requires identification of the particular equity item, its economic substance and the applicable legal and accounting regime.

Positive profit for the current accounting period

The most typical distributable source is a positive profit for the current accounting period. This represents the profit generated in the most recent accounting period, i.e. the difference between income and expenses recognised in that period.

Retained earnings from previous accounting periods

Another typical distributable source is retained earnings from previous accounting periods. These are profits generated in prior periods which have not been distributed to shareholders and have remained in the company. In practice, this item may be more significant than profit for the current accounting period, as the company may have accumulated profits over an extended period of time.

Share premium

Share premium arises where, upon incorporation of the company or an increase in participation, a shareholder contributes to the company an amount exceeding the amount recorded as registered capital.

From a legal perspective, share premium is not value attached to a particular person and does not constitute a separate receivable or claim that would be automatically repayable to the shareholder who created it. If its economic effect is reflected back to shareholders, this is achieved through the distribution of other own resources. Such distribution is generally made pro rata according to the shareholders’ participation in the company, unless the rights attached to the relevant shares provide otherwise. This result may therefore be modified by an appropriate structuring of the rights attached to shares, in particular as regards the share in profit or in other own resources.

Share premium may be distributed only to the extent that it constitutes genuinely distributable own resources. In particular, it must not be subject to any statutory restriction or allocation, or to any restriction or allocation under the company’s constitutional document.

Other capital funds, including contributions outside registered capital

The accounting item of other capital funds may constitute a distributable source, depending on its specific composition.

This item may include various capital transactions which do not constitute registered capital or share premium. In addition to contributions outside registered capital, it may include other forms of capital contributions or capital strengthening of the company.

Only the portion that represents freely distributable capital resources and is not subject to any special statutory or constitutional allocation or restriction may be distributed.

In a limited liability company, the economic effect of a contribution outside registered capital is attached to a specific share and is therefore returned to the person who provided the contribution or, as applicable, to the person who acquired the share to which the contribution is attached. In a joint-stock company, by contrast, a contribution outside registered capital is reflected in the company’s total equity and, absent any specific arrangement, is distributed among shareholders pro rata. This outcome may likewise be modified by a different structuring of the rights attached to shares, for example by determining the shares in profit or in other own resources on a basis other than pro rata allocation so as to reflect differences in the economic contributions of individual shareholders.

Items arising from transformations of business corporations

In relation to items arising from transformations of business corporations, the individual types must be distinguished. Differences from valuation in transformations of business corporations, differences from transformations of business corporations and valuation differences from revaluation in transformations of business corporations may be distributed. By contrast, valuation differences from the revaluation of assets and liabilities may not be distributed, as they constitute a restricted item relating to the temporary revaluation of a specific financial asset.

Funds created from profit

Funds created from profit constitute a separate equity item. In the balance sheet, they are further subdivided primarily into other reserve funds and statutory and other funds. However, not every fund created from profit is automatically distributable. Only a fund that the company may use at its discretion may be distributed, i.e. a fund that is not subject to a statutory or constitutional allocation or restriction. A mandatory reserve fund, a fund for treasury shares or, for example, a social fund cannot be distributed precisely because of their restricted purpose. It is therefore always necessary to review the purpose of the funds and the conditions governing their creation and use.

Other profit or loss from previous accounting periods

Other profit or loss from previous accounting periods cannot automatically be regarded as non-distributable. If positive, it may form part of the amount available for distribution; if negative, it reduces that amount. It is nevertheless always necessary to assess the substantive nature of this item and whether it may be taken into account when determining distributable own resources.

Registered capital and interim profit distribution

Registered capital itself forms part of equity; however, any return of registered capital, in particular in connection with a reduction of registered capital, is subject to a separate legal regime and must not be confused with the ordinary distribution of profit or other own resources. The accounting item recording changes in registered capital also does not constitute a separate distributable source; it is merely a transitional accounting record reflecting the process of changing registered capital.

Similarly, the accounting item recording an interim profit distribution that has already been resolved cannot be distributed. It does not represent a new own resource, but merely reflects, for accounting purposes, the fact that the interim distribution has already been resolved and has been recognised in the company’s equity.

Summary

The principal equity items available for distribution include positive profit for the current accounting period and retained earnings from previous accounting periods. In addition, share premium and other capital funds may, in particular, constitute other own resources available for distribution. In the case of other own resources, it is always necessary to determine whether they are subject to any statutory or constitutional allocation or restriction.

Share premium and contributions outside registered capital, which fall within other capital funds, are subject to different legal regimes and must not be conflated. Share premium does not constitute an individual claim of a particular shareholder and, where its economic effect is reflected back to shareholders, this is effected within the general distribution of other own resources, usually pro rata according to participation, unless otherwise provided.

In the case of contributions outside registered capital, their specific legal and economic nature must be taken into account. In a limited liability company, their economic effect is attached to a specific ownership interest, whereas in a joint-stock company, absent any specific arrangement, it is reflected in the general distribution among shareholders.

Under the regime governing the distribution of profit and other own resources, the following items in particular may not be distributed: registered capital, items serving solely to record changes in registered capital, valuation differences from the revaluation of assets and liabilities, mandatory reserve funds, the fund for treasury shares, the social fund and amounts reflecting an interim profit distribution that has already been resolved.