Dividends and the Legal Reserve: Calculating the Dividend Limit and Comparing Limited and Public Limited Companies

Note: The English text of the laws is an unofficial translation for reference. The Thai text is authoritative.

Dividends and the Legal Reserve of Thai Limited Companies: What Does “Profit” Mean in Section 1202 of the Civil and Commercial Code?

How the maximum dividend of a private limited company is to be calculated is in fact not a simple question. As quoted below, Section 1202 of the Thai Civil and Commercial Code merely provides that the legal reserve must be at least one-twentieth of the “profit”, and the meaning of this “profit” is unclear. The document generally cited in Thailand on this question is the “Q&A on Financial Reporting Standards” (January–February 2016) published by the Federation of Accounting Professions (สภาวิชาชีพบัญชี). It states as follows (summary):

Example

• Accumulated loss brought forward at the beginning of 2015 (B.E. 2558): THB 100
• Net profit after tax for 2015: THB 1,000
• Retained earnings carried forward at the end of 2015: THB 900

Answer

Dividends may be paid only out of the profit portion, i.e. up to THB 900, because no dividend may be paid until losses have been made good. The reserve is to be set aside only from the portion of earned profit after deducting the accumulated loss, i.e. at least 5% of the THB 900 to be declared as a dividend (setting aside more is permitted).

The first issue here is whether the base is the entire net profit for the year of THB 1,000, or the THB 900 that remains after excluding the accumulated loss of THB 100. The answer adopts the latter, which seems unproblematic. The second issue is the maximum amount of dividend, i.e. the dividend limit, and on this point the answer is unfortunately ambiguous.

Legal reserve rules can generally be classified into three types: (1) the profit type, which takes each year’s profit as the base only once (as in Germany and the Thai Public Limited Companies Act); (2) the dividend type, which takes the amount paid out as dividends as the base (as in Japan); and (3) the distributable-amount type, which regulates the source of dividends (as in the UK and the US). Japanese readers will recognise that type (3) has also been partly adopted in Japan.

In this example, the answer merely says that the legal reserve must be at least THB 900 × 5%. It is framed so as not to address whether, if a dividend of THB 500 rather than the full THB 900 were paid, the amount to be set aside would be THB 900 × 5% under view (1) or THB 500 × 5% under view (2). There also appears to be a contradiction in first stating that THB 900 may be paid as a dividend and then requiring a legal reserve (if THB 900 were paid, nothing would be left from which to fund the reserve). It seems that the answer deliberately avoided addressing the point, with both view (1) and view (2) in mind.

Among commonly circulated views, within view (1) there appear to be two positions: one that takes the sum of retained earnings brought forward and the current year’s net profit as the multiplicand to which 5% is applied, and one that takes only the current year’s net profit. We do not adopt the former, because the legal reserve calculated on that multiplicand when dividends are paid would be counted twice. Avoiding this would require complex calculations and would be an excessive application of the capital maintenance principle. For example, if in the example a dividend of THB 500 is paid in 2015 and the legal reserve is set aside using the retained earnings of THB 900 at the end of 2015 as the multiplicand, and in the following year net profit is again THB 1,000 and a dividend of THB 500 is again paid, then using 355 (= 900 − dividend 500 − reserve 45) + 1,000 = THB 1,355 as the multiplicand would result in THB 355 being subjected to the reserve twice.

As to whether view (1) or view (2) is correct, there appears to be, in fact, no authoritative interpretation. Neither a view from the Thai authorities, such as the Department of Business Development (DBD) of the Ministry of Commerce, nor a Supreme Court decision can be found. Thai academic opinion is also divided: Thipchanok Rattanosot adopts the view that the base is net profit as a whole, while Sahathon Rattanapaijit and Nonthawat Nawatrakulpisut adopt the view that the base is the profit paid out as dividends in the period, i.e. view (2).

Our firm, however, supports view (2), for the following reasons.

(1) In Supreme Court Judgment No. 7671/2546, the court held that the purpose of Section 1202 of the Civil and Commercial Code is “so that the company does not pay out all of its profits as dividends to shareholders until it lacks working capital to carry on its business”, thereby recognising the principle of capital maintenance as its purpose. In that light, it is sufficient to set aside a reserve on the profit corresponding to the amount of dividends paid out. On the other hand, taking the entire net profit for the year as the base regardless of the amount of dividends appears to be an excessive application of the capital maintenance principle. For example, setting aside THB 500,000 as a legal reserve against a net profit of THB 10 million even where a dividend of only THB 100 is paid would be going too far, even in light of the purpose of Section 1202.

(2) If a limited company is regarded as the most advanced form of raising capital, taking the entire net profit for the year as the base would needlessly deprive shareholders of an important right that underpins it, namely the shareholders’ right to receive dividends.

(3) Section 116 of the Thai Public Limited Companies Act, the legal reserve provision for public companies (see below), is similar to Section 1202 of the Civil and Commercial Code, which applies to private limited companies. However, it requires a reserve of at least 5% of each year’s net profit less any accumulated loss brought forward. In other words, it covers the whole of the year’s net profit after deducting the accumulated loss, irrespective of whether dividends are paid. By comparison, reading the Civil and Commercial Code provision, which requires a reserve “each time a dividend is distributed”, as referring to the whole of the current year’s profit is untenable.

In practice, as shown below, there appear to be no significant penalties, so it seems that either view (1) or view (2) may be adopted. We recommend, however, bearing in mind that under view (2) there is a risk that the authorities or the auditor may take a different view, and that under view (1) the profit concerned cannot be distributed until the company is dissolved.

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Thai limited companies (บริษัทจำกัด): dividends and the legal reserve

Dividend limit (Civil and Commercial Code §1201)

No dividend may be paid out of any funds other than profits. If the company has incurred losses, no dividend may be paid until the losses have been made good (Section 1201, Civil and Commercial Code).

Amount of the legal reserve (Civil and Commercial Code §1202)

Each time a dividend is distributed, the company must set aside as a reserve at least one-twentieth of the profits arising from its business, until the reserve reaches one-tenth of the company's capital or more (Section 1202, Civil and Commercial Code).
*The Civil and Commercial Code only says the reserve must come from profits; it does not specify which profits.

Penalties for dividend and legal reserve violations

Thai public limited companies (บริษัทมหาชนจำกัด): dividends and the legal reserve

Dividend limit (Public Limited Companies Act §115)

No dividend may be paid out of any funds other than profits. While the company still has accumulated losses, no dividend may be paid (Section 115, Public Limited Companies Act).

Amount of the legal reserve (Public Limited Companies Act §116)

The company must set aside as a reserve at least 5% of its annual net profit less any accumulated losses brought forward, until the reserve reaches at least 10% of its registered capital (Section 116, Public Limited Companies Act).
*The Public Limited Companies Act clearly states that the reserve must come from annual net profit.

Liability for unlawful dividends (Public Limited Companies Act §118 and §91)

Frequently asked questions: dividends and the legal reserve in Thailand

1. If there is a profit, must a legal reserve be set aside every year?

• A limited company sets aside the legal reserve only when it pays a dividend.
• A public limited company, however, must set aside a reserve from net profit even in a year in which it declares no dividend.

2. Or must the reserve be set aside each time before a dividend is paid?

• See the answer to question 1.

3. Must the reserve be complete (one-tenth of capital or more) before a dividend can be paid?

• No, there is no need to wait until the reserve is complete. If a limited company pays no dividend, it does not need to set aside a reserve at all.
• The same applies to a public limited company: there is no need to wait until the reserve is complete. However, a public limited company must set aside a reserve from net profit even if it declares no dividend.

Civil and Commercial Code (unofficial translation)

Section 1201. No dividend may be declared except by a resolution of a general meeting.

The directors may from time to time pay interim dividends to the shareholders when it appears to them that the profits of the company justify such payment.

No dividend may be paid out of any funds other than profits. If the company has incurred losses, no dividend may be paid until the losses have been made good.

Payment of the dividend must be completed within one month of the date of the resolution of the general meeting or of the directors, as the case may be.

Section 1202. Each time a dividend is distributed, the company must set aside as a reserve fund at least one-twentieth of the profits arising from its business, until the reserve fund reaches one-tenth of the capital of the company or such larger proportion as may be provided in its regulations.

If shares have been issued at a price above their face value, the excess must be added to the reserve fund until the reserve fund reaches the amount prescribed in the preceding paragraph.

Act Prescribing Offences Relating to Registered Partnerships, Limited Partnerships, Limited Companies, Associations and Foundations, B.E. 2499 (1956) (unofficial translation)

Section 19. A limited company that pays a dividend in violation of Section 1201, paragraph one or three, of the Civil and Commercial Code, fails to pay a dividend within the period prescribed in Section 1201, paragraph four, or distributes a dividend in violation of Section 1202 of the Civil and Commercial Code, is liable to a non-criminal fine (phinai) of not more than THB 20,000.

Public Limited Companies Act B.E. 2535 (1992) (unofficial translation)

Section 115. No dividend may be paid out of any funds other than profits. While the company still has accumulated losses, no dividend may be paid.

Dividends are divided equally per share according to the number of shares, unless the articles of association provide otherwise for preference shares. Payment of dividends requires the approval of the shareholders' meeting.

Where the articles of association so permit, the board of directors may from time to time pay interim dividends to the shareholders when it considers that the company has sufficient profits to do so, and must report the payment to the next shareholders' meeting.

Dividends must be paid within one month of the date of the resolution of the shareholders' meeting or the board of directors, as the case may be. The shareholders must be notified in writing, and a notice of the dividend payment must be published in a newspaper.

Section 116. The company must set aside as a reserve at least 5% of its annual net profit less any accumulated losses brought forward, until the reserve reaches at least 10% of its registered capital, unless its articles of association or another law require a larger reserve.

Section 118. If the company pays dividends to shareholders in violation of Section 115, 116 or 117 and this prejudices its creditors, the creditors may sue the shareholders for the return of the dividends received. The action must be brought within one year of the date of the shareholders' resolution. Shareholders who received dividends in good faith cannot be compelled to return them.

Section 91. The directors are jointly liable for any damage caused to the company in the following cases:

(1) calling on share subscribers to pay for shares, or to transfer ownership of property to the company, without complying with Section 37 or 38;

(2) spending share payments, or disposing of property received as payment for shares, in violation of Section 43;

(3) any act in violation of Section 85;

(4) lending money in violation of Section 89;

(5) paying money or any other property to directors without complying with Section 90;

(6) paying dividends to shareholders in violation of Section 115, or liability under Section 118, unless they prove that they acted in good faith in reliance on evidence or financial reports certified as correct by the chairman, the company's financial officer or the auditor;

(7) failing to prepare or keep the company's accounts, registers or documents under this Act, unless they prove that they took reasonable steps to prevent the violation.

Section 93. Where directors are liable for damage caused to the company under Section 91(6), they are entitled to recover the excess dividends from shareholders who received them knowing that the payment violated Section 115 or gave rise to liability under Section 118.