The share premium account is a reserve on the balance sheet that records the amount shareholders have paid for shares above their nominal (par) value. It is a statutory reserve under the Companies Act 2006 and cannot be distributed as dividends.
When a company issues shares at a price higher than the nominal value, the excess is credited to the share premium account rather than to share capital.
How Share Premium Arises
Every share in a UK company has a nominal value (also called par value), which is the minimum price at which shares can be issued. Most UK companies set this at £1 or even £0.01 per share.
When investors pay more than the nominal value, the difference is the share premium:
| Element | Per Share | 10,000 Shares |
|---|---|---|
| Nominal value | £1.00 | £10,000 |
| Issue price | £3.50 | £35,000 |
| Share premium | £2.50 | £25,000 |
In this example, share capital increases by £10,000 and the share premium account increases by £25,000. Together, the company has received £35,000 in cash.
When Does Share Premium Typically Arise?
- Startup funding – investors pay a premium over nominal value to reflect the company’s potential
- Growth-stage investment – subsequent funding rounds price shares higher as the business grows
- Conversion of convertible loans – when a loan converts to shares at a premium
- Employee share schemes – shares issued to employees at market value above nominal value
- Rights issues – existing shareholders subscribe for new shares at a price above nominal value
Share Premium on the Balance Sheet
The share premium account sits within shareholders’ funds (also called equity) on the balance sheet:
| Balance Sheet Extract | £ |
|---|---|
| Called-up share capital | 50,000 |
| Share premium account | 125,000 |
| Profit and loss account (retained earnings) | 80,000 |
| Total shareholders’ funds | 255,000 |
Under FRS 102 Section 22, share premium must be presented separately from share capital and other reserves. The Companies Act 2006 (Section 610) requires the share premium account to be maintained as a distinct reserve.
Permitted Uses of Share Premium
The Companies Act 2006 (Section 610) restricts what a company can do with the share premium account. It can only be used for:
| Permitted Use | Explanation |
|---|---|
| Issuing fully paid bonus shares | The company capitalises the share premium by issuing new shares to existing shareholders at no cost |
| Writing off share issue costs | Expenses of issuing shares (legal fees, registration fees, broker commissions) can be debited against share premium |
| Writing off commission on share issues | Any commission paid to underwriters or brokers for placing shares |
| Providing the premium on redemption of shares | If shares are redeemable at a premium, the premium payable on redemption can be funded from the share premium account |
What Share Premium Cannot Be Used For
- Paying dividends – share premium is not a distributable reserve
- Absorbing trading losses – unlike the profit and loss account, share premium cannot be reduced by operating losses
- General business expenditure – it is not a fund available for day-to-day spending
- Returning capital to shareholders (without a court-approved capital reduction)
Capital Reduction and Share Premium
A company can apply to the court to reduce its share premium account under Sections 641-653 of the Companies Act 2006. Private companies can also use the solvency statement procedure (Section 642) without court approval if the directors make a statutory declaration that the company can pay its debts.
Common reasons for reducing share premium include:
- Creating distributable reserves – converting non-distributable share premium into distributable reserves so the company can pay dividends
- Eliminating accumulated losses – writing off losses carried forward in the profit and loss account
- Simplifying the balance sheet – reducing an unnecessarily large share premium balance
The reduction must be registered with Companies House and takes effect on registration.
Merger Relief and Group Reconstruction Relief
Section 612 of the Companies Act 2006 provides merger relief, which exempts a company from recording share premium in specific circumstances:
- The issuing company secures at least a 90% equity holding in the target company
- The shares are issued as consideration for the acquisition
When merger relief applies, the premium on the shares issued is not credited to the share premium account. Instead, it may be credited to a merger reserve, which has more flexible uses than the share premium account.
Group reconstruction relief (Section 611) applies when shares are issued in connection with a transfer of undertaking between group companies.
These reliefs are particularly relevant in corporate restructurings and group reorganisations.
Accounting Treatment Under FRS 102
Under FRS 102 Section 22 (Liabilities and Equity):
- Share premium is classified as a component of equity
- It is presented separately on the balance sheet
- Changes in share premium during the period are disclosed in the statement of changes in equity
Journal Entry for Issuing Shares at a Premium
When a company issues 5,000 shares with a nominal value of £1 at an issue price of £4:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Bank | 20,000 | |
| Share capital | 5,000 | |
| Share premium account | 15,000 |
Writing Off Share Issue Costs Against Share Premium
If the company incurs £3,000 in legal and professional fees for the share issue:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Share premium account | 3,000 | |
| Bank / Creditors | 3,000 |
This reduces the share premium account from £15,000 to £12,000.
Share Premium and Tax
Share premium has no direct tax implications in most cases:
- Issuing shares at a premium is not a taxable event for the company
- Stamp duty may be payable by the purchaser on the transfer of shares (at 0.5% of the consideration), but this applies to transfers of existing shares rather than new issues
- Capital reduction involving share premium does not normally create a tax liability, but specialist advice is recommended as the position depends on the specific circumstances
Share Premium vs Other Reserves
| Reserve | Source | Distributable? |
|---|---|---|
| Share premium | Amount paid above nominal value on share issues | No |
| Retained earnings | Accumulated profits less dividends | Yes |
| Revaluation reserve | Upward revaluation of fixed assets | No (until asset is sold) |
| Capital redemption reserve | Created when shares are redeemed or purchased out of distributable profits | No |
| Merger reserve | Premium on shares issued under merger relief | Depends on circumstances |
Understanding the distinction between distributable and non-distributable reserves is essential when determining whether a company has sufficient reserves to pay dividends.
Share Premium in Practice
Early-Stage Companies
A startup issuing shares to angel investors will typically create a significant share premium. If the company has 100 shares of £1 nominal value and issues 20 new shares at £50 each to an investor:
| Item | £ |
|---|---|
| New share capital (20 x £1) | 20 |
| New share premium (20 x £49) | 980 |
| Total investment | 1,000 |
The share premium account holds £980 of the £1,000 investment. This money is available for the business to use operationally, but the reserve itself remains non-distributable.
Established Companies
For established companies, share premium may arise from rights issues, employee share option exercises, or acquisition-related share issues. The balance can grow substantially over time, particularly in companies that have raised multiple rounds of external funding.
Common Questions
Can a company issue shares below nominal value?
No. Section 580 of the Companies Act 2006 prohibits issuing shares at a discount to nominal value. This is why companies set low nominal values – it provides flexibility to issue shares at any price above that nominal value without breaching the law.
Does share premium affect the value of existing shares?
Issuing shares at a premium increases total equity and the number of shares in issue. Whether this increases or decreases the value of existing shares depends on whether the issue price reflects the company’s current value per share. If shares are issued at less than their true worth, existing shareholders are diluted.
Is share premium the same as share capital?
No. Share capital records the aggregate nominal value of all issued shares. Share premium records the excess over nominal value. Both are part of equity but serve different legal and accounting purposes.