The concept of distributable profits and dividends from a company law and fiscal perspective

Abstract

The proper functioning of a limited liability company includes as one of its main aspects the distribution of its profits to shareholders. In the modem business context decisions relating to distributions have become subject to internal and external influential forces which unless given proper consideration by company directors, could have a negative impact even on the very commercial existence of a company. The objectives of this thesis are to attempt a study of two of the most important such influential forces on distribution decisions. Firstly, the company law restrictions relating to the extent of profits which may be legally distributed in the context of the capital maintenance doctrine and, secondly, the fiscal implications of dividend distributions arising both at company and at shareholder level. In this area, Maltese company law, which is closely based on its English counterpart, is concerned with ensuring that distributions are mad~ only from available dist~butable profits in order for creditors to be afforded appropriate protection against any possible over-distribution of profits to shareholders. A discussion on the determination of the funds legally available for distribution to shareholders necessitates an understanding of the basic concept of profit and the difficulties which are sometimes encountered in determining the precise amount of a company's distributable profits. This includes issues involving the possible differences in the position of private and public companies, dangers of over-distributing and in a group of companies scenario, the possible implications on distribution of the distinction between pre and post acquisition profits. However, it is concluded that the most important aspect of the legal restrictions on dividend distributions is the distinction between realised and unrealised profits, a study of which requires reference to issues and guidance arising from the accounting world, where this distinction is derived from. The company law concept of distributable profits is also the starting point adopted by Maltese tax law as it lays down the fiscal treatment of dividend distributions. This is characterised by the workings of the full imputation system and the refunds mechanism which combine to create an attractive tax regime for foreign investment. A study of this fiscal perspective requires an analysis of the recent changes to the Maltese tax system, particularly, those affecting the allocation of distributable profits to the tax accounts as well as, the resultant treatment of dividends once they are distributed to shareholders and become subject to the tax refunds mechanism. However, distributions made by Collective Investment Schemes have been specifically excluded from the scope of this thesis. While such changes to the Maltese tax system have m fact consolidated Malta's attractiveness as a favourable tax regime, practical problems arising from the complications that surround ascertaining legally distributable profits still limit companies from taking full benefit of the tax system. The current approach taken by company law, relying on the distributable and realised profits test can be criticised as being too complex and somewhat ineffective. Widespread calls for reform in this area, mainly pointing to introducing a solvency-based regime, are shared. However, the important observation must be made that the best way forward is that which best negotiates the issues raised in all three spheres of company law, tax law and accounting principles.