What requirements must be met when dividends are distributed?

A question that frequently arises in companies is how shareholders can personally benefit from their investment in the company. For legal advice on these matters, having a tax lawyer in Málaga can be key. Merac has lawyers in Mijas y lawyers in Benalmádena.
In this regard, it is important to take into consideration that the only way a shareholder can receive money from the company, in their capacity as shareholder, is through the distribution of dividends. 

What are dividends?

Dividends are the profits generated by the company that are distributed among its shareholders.

Therefore, the main requirement for a distribution of dividends to be carried out is that the company has generated profits, either in previous years or during the current year.

Therefore, depending on what the dividend distribution is charged to, we can distinguish between the different types of dividend distribution, each of which must meet a series of requirements.  

Distribution of dividends from the allocation of profit 

As we know, within six months of the end of the financial year, shareholders must meet at an Ordinary General Meeting to approve the annual accounts for the previous year and decide on the allocation of profit. 

In the event that the company has generated profits during the year, a distribution of dividends may be agreed, provided that the following requirements are met: 

Funding of the legal reserve and statutory reserves

Before distributing dividends the legal reserve and the reserves provided for in the Articles of Association must be funded. 
In the case of the legal reserve, in accordance with article 274 of the Capital Companies Act, 10% of the year's profit must be allocated to this reserve until it reaches at least 20% of the share capital. 

Therefore, if the legal reserve has not been funded up to 20% of the share capital, at least 10% of the profits obtained must be allocated to the legal reserve before any distribution of dividends is agreed. 

Research and Development (R&D) expenses

If research and development expenses are recorded as assets on the balance sheet, dividends may not be distributed unless the amount of available reserves is equal to the amount of those R&D expenses recorded as assets. 

Equity

Another requirement to take into account is that, under no circumstances, after the distribution of dividends, may equity be lower than the share capital. 

So, if there were losses from previous years that made equity lower than the share capital, dividends may not be distributed, and the profit must be used to offset losses from previous years. For specific tax and corporate advice, a tax lawyer in Marbella is essential support.

To clarify the above, below is an example of the amount that could be distributed as dividends in a company whose profit for the year whose accounts are approved by the General Meeting is €8,000: 

In this case, the maximum amount that could be distributed would be as follows: 

• • Allocation of profit (€8,000): 
    • To legal reserve (10% of the profit obtained until reaching 20% of share capital): €800.
    • To reserves (for R&D expenses): €2,000

• Dividends to be distributed: €5,200

After the distribution, the balance sheet would be as follows: 

In this case, equity is higher than the share capital; if it had been lower, part of the profit would have had to be used to offset losses from previous years. 

Distribution of dividends charged to reserves

In this case, the distribution of dividends can be agreed either at the Ordinary General Meeting itself (approving the annual accounts) or at an Extraordinary General Meeting, provided that the Company has freely available reserves. 

In this case, the requirements to be met would be the same as for the distribution of dividends from the allocation of profit, set out in the previous section. 

However, as we have indicated, dividends may be distributed from reserves only if those reserves are available, since there may be situations in which the company generated profits in previous years and allocated them to reserves, but those reserves subsequently became restricted for various reasons, some of which are set out below: 

• If a reduction in share capital has been agreed to offset losses, in order for the company to distribute dividends once the share capital has been reduced, the legal reserve must reach at least 10% of the new capital (art. 326 LSC).
• In the case of a capital reduction with return of contributions, if a reserve has been created from profits or free reserves for an amount equal to that received by the shareholders, in order to exclude them from any joint and several liability for the amount returned, that reserve will be restricted for a period of five years from the publication of the reduction resolution in the BORME and therefore may not be distributed.

Interim dividends charged to the current year's profit

The law allows interim dividends to be distributed among shareholders.

In this case, it does not need to be agreed by the General Meeting; it may be agreed by the Meeting or, where applicable, by the directors, provided that the following conditions are met:

• There must be sufficient liquidity for the distribution; to this end, the management body will prepare a financial statement showing that there is liquidity. This statement must subsequently be included in the Notes to the accounts for the year in which the distribution is agreed.
• The amount to be distributed may not exceed the results obtained since the end of the last financial year, after deducting: (i) losses from previous years; (ii) the amounts to be allocated to reserves required by law or by the articles of association and (iii) the estimated tax payable on those results.

Therefore, the above items must be deducted from the profits generated during the current year and, once deducted, we will obtain the maximum amount that could be distributed as an interim dividend, provided that there is sufficient liquidity and this is reflected in the financial statement prepared by the management body.

How are dividends distributed?

The dividends are distributed among shareholders in proportion to their holding in the share capital, unless there is a provision to the contrary in the articles of association or different classes of shares within the company, for example, if some shares are granted greater economic rights, in which case the distribution will not be proportional.

Likewise, if the articles of association establish a per capita distribution, the distribution is not in proportion to their holding in the share capital but equal among all shareholders.

It is therefore necessary to know in detail the type of shares in a company and their rights, in order to determine the dividends each shareholder is entitled to receive.

What is the deadline and method for paying the agreed dividends?

The time and method of payment will be determined by the general meeting itself, and a cash or in-kind dividend may be agreed.

However, as regards the deadline, article 276 LSC establishes that dividends must be paid in full within a maximum period of twelve months from the date of the general meeting resolution approving their distribution.

What happens if the distribution of dividends does not meet the necessary requirements?

In this regard, it is important to note that article 278 of the Capital Companies Act expressly establishes that any distribution of dividends or interim dividends that does not meet the established requirements must be returned by the shareholders who received it, with the corresponding legal interest, provided that the company proves that the recipients knew of the irregularity of the distribution or that, given the circumstances, they could not have been unaware of it.

Considerations

Regardless of the type of dividend distribution chosen, the following must be taken into account when agreeing on the distribution:

• If there is a preferred dividend in favour of certain shares within the company, this priority dividend must be covered before the distribution.
• The time and method of payment of the agreed dividends must be established. The maximum period for full payment of the dividends will be twelve months from the date of the resolution of the general meeting at which their distribution was agreed.
• For any further queries and specialised advice, do not hesitate to contact our lawyers in Málaga.