Sometimes a company has cash but no distributable reserves, so it can’t pay dividends. Capital reductions can be used in certain circumstances to create distributable reserves which can then be paid in dividends.
For example, a company may have issued shares at a premium but initially made losses. Once it becomes profitable and cash generative it may wish to reward shareholders. However, the company cannot pay dividends if it doesn’t have sufficient retained earnings.
Share premium £5m
P&L account deficit (£2m)
This company could use a capital reduction to reduce its share premium by £3m and transfer it to the P&L account, giving £1m retained earnings. It could then use its cash to pay £1m in dividends.
This is just a simple example, however please contact us to find out more information, or for references to Companies Act 2006 etc.
Refer to Reduction of capital for more details.