In brief
The consultation paper (“Consultation”) published by the Department for Business, Innovation, Science and Trade (“DBIST”) on 7 September 2026 (see our previous legal update “Governance Bite giving a broad overview of the Consultation”) proposes that the current requirement that a UK-incorporated company must have sufficient distributable profits (“DPs”) to make a lawful distribution (such as a cash dividend), which at present are set out in Part 23 Companies Act 2006 (CA 2006) and the parallel capital-maintenance rules under the common law, should be replaced with a new test based on the on-going solvency of the company. We expect that the proposal will also apply to other corporate acts regulated by CA 2006 that require a company to have and apply DPs, such as a share buyback.
Comment
The proposal in this respect in the Consultation represents a revolutionary change in the rules governing distributions. If implemented, the proposal would overturn decades of established law and practice and would entirely overhaul the way in which boards approach distributions. Although the Consultation lacks detail, the consequences of the adoption of a replacement regime are wide-ranging and challenging. We set out below some initial thoughts on the proposal. We welcome the release of the Consultation but anticipate that a great deal of work will be required to replace the current legislation, guidance and common law.
The current regime
Under Part 23 CA 2006, a company may make a lawful distribution only out of its “profits available for the purpose”: i.e., its accumulated, realised profits less its accumulated, realised losses. The existence of those DPs is determined by the directors having regard to “relevant accounts”, which are usually the company’s last audited, annual accounts as circulated to the members, that comply with the statutory requirements for “relevant accounts”. Whether a profit (or loss) that is recorded in those relevant accounts is to be accounted for as a realised profit (or loss) is determined by reference to the Institute of Chartered Accountants in England and Wales (ICAEW) (and Institute of Chartered Accountants of Scotland (ICAS)) Guidance on Realised and Distributable Profits under the Companies Act 2006 (“TECH 02/17”). Thus, CA 2006 requires analysis of the company's financial position as at the date of the “relevant accounts”: i.e., retrospectively.
On the other hand, the capital maintenance rules under the common law oblige the directors to consider the financial position of the company at the time at which the distribution is in fact made: i.e., look at the position since the date of the relevant accounts and prospectively.
The directors are also subject to a fiduciary duty, when proposing and paying a distribution, to consider whether there are any actual, prospective or contingent obligations (including future trading losses) on the company that are reasonably foreseeable the payment or settlement of which by the company would be jeopardised by the payment of the proposed distribution.
The new regime
The Consultation proposes moving from the current DPs-based regime to a solvency-based regime, which the government acknowledges would represent a fundamental change to CA 2006.
A solvency-based regime would remove the requirement for the current, complex analysis and calculation of DPs in accordance with the associated guidance. The government’s proposal is to require companies to state that the payment of the distribution will not affect the company's ability to continue as a going concern.
The government has identified two primary policy justifications for this proposal. First, the change may address concerns raised in the past by some investors and other stakeholders that the existing capital-maintenance regime may incentivise financial engineering to inflate DPs. Second, the government is mindful that increasing transparency in how DPs are calculated will not reduce the complexity of the existing capital-maintenance regime.
Although the treatment of the relevant proposal in the Consultation (paragraphs 109 to 115) is very brief and contains no details as to the nature of the new test (beyond the statement “The proposal would be to require companies to state that the payment of the dividend will not affect the company’s ability to continue as a going concern”), we believe that, under the new regime once implemented, the lawfulness of a distribution would have to be justified by the directors undertaking a forward-looking assessment of the company’s continuing solvency (rather than, as required at present, a calculation of the company’s accumulated DPs). In other words, the directors would have to undertake an analysis of the company’s current and future (query over what period: 12 months?) financial position and proceed only if they can reasonably conclude (and “state”) that payment of the proposed distribution would not affect the company's ability to continue as a going concern. CA 2006 already contains a solvency statement-based procedure for the reduction of a company’s capital: we expect that the detail and requirements of that procedure will probably influence the government’s approach to the legislative changes necessary to implement the new regime.
Some consequences of adopting the new regime
- Replacement of the balance-sheet test with one based on the directors’ judgment: the test of the lawfulness of a distribution would move from the current accounts-driven analysis of the company’s DPs to one based on the judgment of the directors in respect of the continuing ability of the company to pay its debts as they fall due and to continue as a going concern. The adoption of a new solvency-based test will mean that the statutory procedure to pay a distribution will in future be treated more like the existing statutory procedure to effect a reduction of the company’s capital. The government has given no indication (yet) of the impact that the introduction of the new distributions regime may have on the existing capital-reduction procedure.
- Increased responsibility for, and liability of, the directors: as mentioned, CA 2006 already contains a solvency statement-based procedure for the reduction of a company’s capital (including criminal liability in certain circumstances for breach of the statutory requirements). It is likely that the new regime will adopt something similar. If so, the new test will make the directors wholly responsible for the assessment of the company’s position and prospects, perhaps increasing the risk of personal liability for the amount of any distribution that was justified by a solvency statement that was made without reasonable grounds for its conclusions. Query what financial information, including forecasts, will be regarded as necessary for the directors to consider when undertaking a solvency-based assessment? The solvency statement-based procedure for the reduction of a company’s capital does not specify the financial information to which the directors should have regard: will the distribution-related concept of “relevant accounts” under CA 2006 be abandoned altogether? We hope that the new regime will address these procedural matters.
It is also worth noting that the government's broader proposals in Chapter 4 of the Consultation contemplate moving the existing detailed financial reporting requirements out of CA 2006 (and secondary legislation) and into accounting standards: the interaction between that development and any amendment to, or replacement of, the concept of “relevant accounts” will need careful consideration.
Also, the common law at present provides some guidance on the focus of the statutory duty on directors to promote the success of the company (in section 172 CA 2006) when proposing a distribution so that they are required to consider, or to act in accordance with, the interests of the company's creditors when the company becomes insolvent, or when it approaches, or is at real risk of, insolvency. Again, we expect that the new regime will have to recognise the existence of that duty and provide guidance to directors in those circumstances. - Increase in other reserves that may be used to justify a distribution? It is conceivable that the removal of the current requirement for DPs may render more reserves distributable than is the case at present, including profits that are now treated as unrealised under TECH 02/17. The implementation of the new regime will of course introduce material changes to the accounting treatment of distributions: query, for example, the impact on the balance sheet if a distribution exceeds the amount of the company’s stated profits? Although this may free up capital for some companies, the same dynamic may concern creditors and could, in due course, prompt greater judicial scrutiny of directors' solvency assessments, particularly in light of the government’s emphasis that it is keen that the needs of both investors and creditors are met effectively.
- Deemed distribution arising on the intra-group sale of a non-cash asset: under section 845 CA 2006, a distribution arises when a company sells a non-cash asset to any member of the company's group and, under that section, provided that the conditions to the availability of section 845 have been satisfied and the consideration received by the selling company is not less than the book value of the relevant asset (assuming that the Book Value (BV) is less than the market value of the asset), the amount of the distribution is deemed to be zero. One of the conditions to the availability of that provision (which is hugely useful in practice) is that the selling company must have at least some DPs (even if only 1 p). The new regime will have to address the treatment of deemed distributions of that nature if the current DPs-related condition is to be abandoned.
- Distributions in specie: at present, section 845 CA 2006 allows a company to make a distribution of specific non-cash assets at their book value (assuming that the BV) is less than the market value of the asset). We would welcome any clarification from the government that the new regime will continue to permit distributions in specie at the BV of the non-cash asset.
- Impact on intermediate holding companies: in the context of certain intra-group transactions (e.g., the waiver by a grand-subsidiary of a liability owed to it by its grand-parent), the common law at present imposes a test for any intermediate holding company to determine whether the act of its subsidiary amounts to an unlawful return of capital by the intermediate holding company. One part of that test requires the intermediate holding company to have DPs. The introduction of the new regime will likely require the introduction of a different test in those circumstances.
- Consequences of an unlawful distribution: CA 2006 specifies consequences for a company’s failure to comply with the rules in Part 23 CA 2006 for a lawful distribution: broadly, the receiving member, subject to a requirement that they had some knowledge of the unlawfulness, is required to repay the unlawful amount to the company. A similar consequence exists under the common law in respect of an unlawful return of capital. Under the common law and in the event that the company cannot recover an unlawful distribution from the recipients, the directors may be held to be personally liable to compensate the company for the amount unlawfully paid. We hope that the new regime will set out clearly the consequences of any failure to comply with the new requirements, for both the directors who caused the company to make the unlawful distribution and the recipients.
- Creditor-protection: the purpose of the rules in Part 23 CA 2006 and the parallel common law is to protect the creditors of the company. If the traditional capital maintenance-based test for a lawful distribution is to be replaced by a test requiring the directors to exercise judgment (presumably on both a subjective and an objective basis), the nature of the protection available to creditors may well change. In some respects, the new regime may improve creditor protection: requiring a genuine, prospective solvency assessment at the time of the distribution could provide a more meaningful safeguard than a retrospective balance-sheet calculation. A solvency-based assessment, however, would also mean that creditor protection depends more heavily on the robustness of the directors’ judgment concerning the company’s solvency.
- Share buybacks: at present, one of the three ways in which a company may fund a repurchase of its own shares is out of DPs. That process is technically characterised under CA 2006 as constituting a distribution. Assuming that the government’s proposal is implemented, we wonder whether that form of buyback will remain available.
- Capitalisation followed by a reduction of capital: many of our clients will be familiar with one of the most frequently encountered routes for a company to generate DPs (usually to cover the amount of any proposed distribution). A bonus issue of a capital reserve is undertaken followed by a solvency statement-based reduction of capital by means of the cancellation of the resulting bonus shares. If the DPs-based regime is abandoned, it is likely that companies will no longer have to undertake those intermediate steps.
- Financial assistance: CA 2006 contains a prohibition on the use by a company of its assets to assist with the acquisition of its own shares or those of its holding company. CA 2006 provides three categories of exceptions from that prohibition, including “conditional exceptions”, one of which states that the prohibition does not apply to a Public Limited Company (PLC) if the amount of any reduction in the net assets of the company that results from the financial assistance being given is provided out of the company’s DPs. The government will have to consider whether that test will be replaced.
Next steps
The Consultation closes at 11:59 pm on 30 November 2026. Those wishing to respond may do so by:
- Submitting a response via the online survey (accessible here); or
- If there are issues accessing the online survey, emailing their response to mcr.review@businessandtrade.gov.uk
We will continue to monitor developments and provide updates as further details emerge.