Positive effect on Distributable reserves
A reduction of share capital has a positive effect on the distributable reserves of a company. It creates a reserve which is treated as a realised profit for accounting purposes (unless, in the case of a reduction confirmed by the court, the court orders otherwise).
As a result, reductions of share capital are frequently undertaken by companies to:
- create distributable reserves;
- increase distribute reserves; or
- reduce accumulated losses.
Accumulated realized losses suffered by a company in previous trading periods can block the payment of dividends, even if the company is now trading profitably. A reduction of share capital can ‘clear’ these past losses so that dividends can be declared.
NOTE: As most readers will be aware, a company can only pay dividends out of distributable profits available for that purpose, being accumulated, realized profits, so far as not previously utilized by distribution or capitalization, less its accumulated, realized losses, so far as not previously written off in a reduction or reorganization of capital.
To return Surplus Capital
In these circumstances, a reduction in capital can be used to return some or all of this cash to shareholders by repaying paid-up share capital.
To facilitate a share Buyback or Redemption
If the relevant company has insufficient distributable reserves to fund a buyback (and a fresh issue of shares or a purchase out of capital is not an option) then a reduction of capital can be undertaken in advance of the buyback to create the required reserves.