While dividends are the result of a happy process, namely the profitable operation of one’s business, the restrictions and difficulties associated with dividend payment have always given grounds for frustration. Particularly troublesome is the treatment of dividends in the course of corporate acquisitions, as the buyer and the seller need to elaborate special techniques for sharing the dividends among themselves.
If operations are profitable, it is a common business requirement that the owner should be able to regularly withdraw the profits generated by the company. But this, too, causes difficulties, as the decision on paying dividends can only be made once a year, at the time the balance sheet is approved. This can result in a situation that profits generated early in a year can be distributed to the shareholders more than a year afterwards (at the time of the approval of the relevant year’s financial statements), and this can cause liquidity problems for the owner – whether a private individual or a multinational corporation.
Withdrawing dividends mid-year
Although the option of paying an advance on dividends does provide an opportunity for withdrawing dividends mid-year, this too can be tricky. This is because paying an advance on dividends is only permitted subject to the approval of an interim balance sheet, and the rules for preparing one are essentially the same as those for compiling the annual report. And life isn’t made any easier by the fact that – similarly to the annual balance sheet – the interim balance sheet also has to be approved by the auditor.
Unfortunately, the legislation introduced in recent years has done little to simplify matters in this regard. For a long time, the Accounting Act permitted the interim balance sheet to be taken into account for the purpose of determining the advance on dividends for a further 6 months following its effective date (in other words, on the basis of an interim balance sheet compiled on 1 July, several advances on dividends could be withdrawn up until the end of the year). However, the new Civil Code that took effect in March 2014 put a stop to this. According to the new rule, upon each occasion of paying an advance on dividends, the company needs to prove that the preconditions for the payment are in place. Both the tax authority and the courts interpret this rule as meaning that a new interim balance sheet is required for each dividend advance payment.
And nor is it an ideal solution for the company to grant the owners a temporary loan. This is because the loan between a parent company and its subsidiary is classified as a transaction between related parties, which the parties must substantiate through detailed transfer pricing documentation. The administration related to this can often be as complicated as the preparation of an interim balance sheet.
Managing dividend woes during a company acquisition
Settling for the pro-rata profit can also present a problem in the course of company acquisitions where the parties divide the profit for the current year between them on the basis of an interim balance sheet. Let’s suppose that the acquisition takes place on 30 September and the profit generated up to that point is payable to the seller based on the interim balance sheet. At the time of determining the final dividend (that is, in the spring of the following year), however, the seller will no longer be the owner. This can create a problem, as dividend is only due to someone who is a shareholder of the company at the time of the decision.
This situation can be managed by using the provision of the Civil Code under which the parties may depart from the above rule and stipulate that those company members are entitled to the final dividend who were listed in the shareholder register at a given time (e.g. 30 September of the previous year). This way it can be ensured that the dividend is, in fact, payable to the seller.
But even then, problems may still arise. If, for example – due to the company’s loss-making operation in the remainder of the year – at the close of the balance sheet it turns out that not enough profit was generated during the year to cover the advance on dividends paid out to the seller earlier, then it will be possible to claw back a part of that advance from the seller. The seller will unlikely want to take on the risk of this happening. For this reason, in the course of M&A transactions, the parties are forced to use complicated legal structures to ensure that the seller can retain its right to its due share of the dividend.
In an international corporate group, it may be a requirement that the dividend should be moved along the chain of the corporate group as soon as possible, to ensure that it is transferred rapidly from the company at the lowest tier of the group to the ultimate parent company. The Accounting Act provides an opportunity to do this. However, in order to make use of it, the timing of the approval of the balance sheets is critical.
It’s important that the parent company only adopts a resolution on the approval of the financial statements and the payment of dividend, once its subsidiary has already done so. It may only be achieved this way that the accounting rules allow the parent company to on-pay, in the given financial year, the dividend of the subsidiary to its own shareholder.
Under Hungary’s present financial regulations, it is sometimes harder to pay out dividends than it is to generate the profits for them in the first place. And as long as this has the potential to cause serious headaches and liquidity problems for businesses in Hungary, it will continue to substantially hurt Hungary’s competitiveness internationally.