Requirements for the distribution of dividends in companies

The rules for distributing dividends in capital companies are set out in Royal Legislative Decree 1/2010, of July the 2nd, which approves the Capital Companies Law (hereinafter, LSC). However, these rules appear dispersed throughout the entire legal text, so below we summarize the criteria that must be taken into account by the General Meeting when approving the distribution:

1. Dividend distribution: agreement

The distribution of the dividend must be agreed, in any case, in accordance with the provisions of article 273 LSC, charged to freely available profits or reserves. Thus, the distribution may be made against the voluntary reserve, the share premium reserve, the profit and the remainder, while the distribution against the share capital, the legal reserve and the amortized capital reserve will not take place. In the case of the statutory reserve, we must comply with what is stipulated by the Bylaws.

2. Essential requirement: provide legal reserve

It will be an essential requirement for the distribution to provide the legal reserve with 10% of the profits until reaching at least 20% of the share capital, as provided in article 274 LSC.

3. R&D expenses

Another aspect to consider when proceeding with the distribution of dividends is that related to R&D expenses, since as can be deduced from article 273 LSC, an available reserve must be set aside that is at least equal to the amount of the research and development that appear on the balance sheet assets, if these exist.

4. Self portfolio

In the case of companies that have shares or participations acquired through treasury stock (which appear subtracted from own funds), article 142 LSC establishes the obligation to maintain a reserve for their amount as long as they are not sold.

5. If there has been a previous capital reduction

The last requirement is established by article 326 LSC, according to which, for the company to be able to distribute dividends after a capital reduction, the legal reserve must reach at least 10% of the share capital. If the legal reserve is less than 10%, then the distribution cannot take place until such percentage is reached.

6. Net worth value

Finally, article 273 of the LSC provides that dividends may only be distributed from the profit for the year, or from freely available reserves, if the value of the net assets is not or, as a result of the distribution, is not lower than the share capital. Furthermore, in the event that there are losses from previous years that would make the net equity value lower than the share capital figure, it will be used to compensate for these losses.

Below, we show an example of dividend distribution applying each of the requirements already analyzed, for a company that presents the following items on its balance sheet in thousands of euros:

Example 1:

ASSET	NET WORTH
20  R&D expenses	Share Capital………… 100
	Legal reserve………… 18
	Voluntary reservation… 40
	Losses……………… (10)
	Treasury stock …………… (5)
	Benefits……………… 10
	TOTAL NET WORTH = 153

• Step 1: We can compute for the distribution, the freely available benefits and reserves, that is, the amounts that correspond to the voluntary reserve (40) and the benefit (10), which amounts to the total amount of 50.
• Step 2: Next, we will provide the legal reserve since the minimum of 20% of the share capital has not been reached. 10% of the profit will be allocated to the legal reserve: 10% of 10 = 1
• Step 3: An available reserve must be provided for at least the amount corresponding to R&D expenses, that is, 20.
• Step 4: A reserve must be set aside for the amount of shares or participations that the company has in treasury stock, that is, 5.
• We also verify that the company can distribute dividends after a capital reduction, in this case the legal reserve reaches at least ten percent of the share capital (18 is more than 10). If the legal reserve were less than 10%, then the distribution could not take place until such percentage is reached.
• Step 6: We will check that the distribution of dividends does not leave the equity reduced to an amount less than the share capital.

Dividends to be distributed= 50 (profit + freely available reserves) – 1 (to provide legal reserve) – 20 (to reserve for the amount of R&D expenses) – 5 (to provide reserve for the amount of treasury stock) = 24

The dividend distribution does not reduce the net equity by an amount less than the share capital: 153 (PN) – 24 (dividend distribution) = 129. The net equity is reduced to the amount of 129, which is higher than the share capital (100 ). Therefore, the amount of 24 may be distributed as dividends.

Example 2:

Another company presents the following items on its balance sheet in thousands of euros:

ASSET	NET WORTH
5  R&D expenses	Share Capital ……………100
	Legal reserve ………………18
	Share premium reserve…15
	Losses …………………… (30)
	Treasury stock ……………… (5)
	Benefits………………… 100
	TOTAL NET WORTH = 198

• Step 1: We can compute for the distribution, the freely available profits and reserves, this is the amounts that correspond to the share premium reserve (15) and the profit (100), which amounts to the total amount of 115 .
• Step 2: Next, we will provide the legal reserve since the minimum of 20% of the share capital has not been reached. In this case, if we provide the legal reserve for an amount of 2, 20% of the share capital is reached, so it will not be necessary to provide the legal reserve for the total of 10% of the profit.
• Step 3: An available reserve must be provided for at least the amount corresponding to R&D expenses, that is, 5.
• Step 4: A reserve must be set aside for the amount of shares or participations that the company has in treasury stock, that is, 5.
• Step 5: In the event that it is known that there has been a capital reduction, the distribution of dividends would not be hindered by the fact that the legal reserve does not reach 10% of the share capital, since this limit is already covered.
• Step 6: We will check that the distribution of dividends does not leave the equity reduced to an amount less than the share capital.

Dividends to be distributed= 115 (profit + freely available reserves) – 2 (to provide legal reserve) – 5 (to reserve for the amount of R&D expenses) – 5 (to provide reserve for the amount of treasury stock) = 103

The distribution of dividend by the 103 indicated would reduce the net equity by an amount less than the share capital: 198 (PN) – 103 (dividend distribution) = 95, therefore, the net equity would be reduced to the amount of 95, which is less than the social capital (100), that is, we cannot distribute the 103.

In this case, the amount of 98 could be distributed as dividends, which is what exceeds the Net Asset Value of the share capital, without leaving the share capital below its current amount, which is 100.