Public Companies Update January 2006

5 PAYMENT OF INTER-GROUP DIVIDENDS

Recent accounting changes relating to the declaration and payment of dividends may have serious implications for groups of companies paying dividends up the corporate chain.

5.1 Old Rules

In summary, under the old rules (which applied to accounting periods beginning before 1 January 2005), a dividend could be treated as a liability in the paying company in a particular accounting period so long as the dividend was proposed before the accounts for that period were signed. So, for example, if a company with a 31 December year end proposed a final dividend for 2004 in March 2005, had its accounts signed in April 2005 and the dividend approved at its June 2005 AGM, the dividend could be recorded as a liability in the company's 2004 accounts even though the dividend was proposed after 2004 and did not technically become a liability of the company until June 2005.

Sticking with the above example, in the context of a group of companies, this meant that the parent company could include in its profits for 2004 a dividend proposed by its subsidiary after the end of the 2004 financial year, even if that dividend was not a liability of the subsidiary in strict legal terms.

In broader terms, the application of the old rules meant that profits could be moved up the corporate chain to support the ultimate parent company's final dividend (in the above example, for 2004) simply by its subsidiaries proposing the relevant dividends, so long as they did so before their accounts were signed.

5.2 New Rules

Under the new rules, which apply to accounting periods beginning on or after 1 January 2005 (and which are enshrined both in IFRS and UK GAAP), dividends can only be recorded in the accounts of the paying company when they become a legal obligation of the payer. For final dividends, this is when they are approved by the company. For interim dividends, this will be when they have been actually paid.

The practical implication of the new rules for groups of companies is that if profits need to be moved up the corporate chain to the ultimate parent company to support its final dividend for a year, the subsidiaries' dividends must be paid (if interim dividends) or approved by shareholders (if final dividends) before the parent company's year end.

If the subsidiaries' dividends are not paid or approved before the parent company's year end, the parent company may have to draw up interim accounts (at a later date than its year end accounts) to support the dividend it had proposed to make.

5.3 Conclusion

Directors of group companies need to revise group policy on the payment and recognition of dividends in the light of these changes so that they only recognise dividends from subsidiaries once they have become a legal obligation for the payer and that they prepare interim accounts, if necessary, to support the dividend that a parent company had proposed to make.

If you require further information on any matter covered in this note, please contact your principal contact at Charles Russell or Simon Gilbert, Clive Hopewell or Alexander Keepin (London), Francis Rundall, Richard Norton, or Adrian Mayer (Cheltenham), Catherine Drew or Geoff Sparks (Guildford) or Peter Elliott (Oxford) on 0207 203 5000.

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