11.8 CAPITALIZATION ISSUE
Where a company has retained a large part of its profits for whatever reasons they may decide to transfer some of these profits into share capital. The directors may decide to capitalise a whole or part of these reserves by putting an entry through the books reducing reserves and crediting the share capital. This they do by issuing new fully paid ordinary shares in the company. In past years this was done to try and avoid dividend tax. There was a transfer from reserves and later these shares were bought back by the company, this then would be a dividend in the hands of the shareholder and the company would have to pay the necessary dividend tax. In many instances the capitalisation was a scheme to avoid dividend tax.
A capitalization issue does not in any way increase the capital resources of the company because there is no movement in cash.
We need to look at this in regard to tax and what we call contributed tax capital, something that will be dealt with later.
Where there is a cash payment made to shareholders in lieu of the capitalization i.e. the issue of the share certificates to the shareholders then the board has to carry out a solvency and liquidity test as this will fall within the definition of a distribution.