Receiving dividends from your limited company is a very tax efficient way of getting cash out of your company however there are some pitfalls that need to be avoided. If you get this area wrong you’re likely to run into trouble with our friends over at HMRC.

One of the key pitfalls is making sure that there are distributable reserves that are sufficient to cover the dividend. Distributable reserves are essentially the cumulative life-to-date profit of the company less any dividends taken out to date. There might be one or two other adjustments in there but for the majority of micro / small business that’s what it will be. You will be able to see the distributable reserves position from your balance sheet. Now the issue you need to be aware of is that at the date that you are declaring the dividend, it is at that date that you need to be confident that there are sufficient reserves to cover the dividend. 

So let’s imagine your annual accounts are draw up 31st March 2012 and you are looking at declaring a dividend on 30th September 2012. You need to assess the reserves position at 30th September, not as it was at year end. This means you will need to draw up interim accounts to 30th September and need to make sure that adjustments are made for items such as corporation tax, stock, work in progress, accruals, depreciation, amortisation, bad debts and provisions. These adjustments may have a material effect on profits available for distribution.

Bear in mind that you are looking at the cumulative reserves position, not just the current year profits or losses – so just because you may have made a loss in the current year, there may be sufficient brought forward profits to permit a dividend.

There are other things that need to be considered in the dividend process but we will cover that in future posts. We can manage clients dividend administration for them as part of our service.

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