What are undistributable reserves and what can be done about them ?

A fundamental principle of UK company law, the preservation of capital, makes illegal the payment of dividends outside liquidation from a company's share capital or undistributable reserves.

If a company is in formal liquidation, this will not apply, as liquidation is the formal process for bringing a company to an end and distributing its assets completely.  Consideration of share capital and undistributable reserves only needs to be undertaken where the directors are winding the company up informally without a liquidation.

Share capital is the nominal amount that has been paid upon issue for a company's shares.  In the event that shares have been sold for amounts in excess of their nominal value, the excess will be taken to the share premium account.

Undistributable reserves are defined as:

The amount of share capital, and reserves i and ii above should be shown in the company's statutory accounts, reserves iii and iv above may be shown or the company's accountants can calculate and advise upon the extent thereof.

Now, as it's technically illegal, the company cannot distribute its share capital and undistributable reserves in an informal winding-up, therefore these reserves will remain, and if the distribution is made, the other side of the equation is a debtor owed by the company's shareholders to the company and equivalent in value.

Upon dissolution of the company, any remaining assets of the company pass to the crown as Bona vacantia . The Treasury Solicitor used to have a limit of £4,000 distribution of share capital or undistributable reserves in an informal winding-up, distributions beyond that level would mean they could attempt to recover any distributions made above this limit.  On 14 October 2011, the Treasury Solicitor solicitor advised though that it would no longer seek to recover distributions of share capital of any amount, due to the simplicity under the Companies Act 2006 of applying to reduce a company's share capital.

Before the Companies Act 2006, companies had to apply to the Court for an order to reduce the share capital.  While this route is still available, the Companies Act 2006 now allows for private limited companies (not PLCs) to reduce their share capital by passing a special resolution and filing this at Companies House together with a solvency statement and statement of capital.  The section of the Companies Act dealing with reduction of capital is shown here .

Philip Beck is a Chartered Accountant and Licensed Insolvency Practitioner operating since 1996 with substantial experience in undertaking liquidation, both solvent and insolvent.

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Members Voluntary Liquidation Questions and answers.

What are the tax advantages of a Members Voluntary liquidation ?

What is the procedure for putting a company into Members Voluntary liquidation ?

Can this be done informally without the expense of liquidation ?

What is Extra-Statutory Concession C16 (ESC C16) ?

What are Undistributable Reserves ?  What can be done about them ?

What is Bona Vacantia ?

How much does it cost to put the company into members voluntary liquidation ?

What is a Section 110 Reconstruction and how can it achieve a tax-efficient disposal of part of a company's business ?

What happens if creditors' claims arise during the liquidation ?

What happens at the end of the liquidation ? Can the company ever be restored to the register if necessary ?

Please note that this site deals only with company and tax law in the United Kingdom of Great Britain and Northern Ireland.   It is not applicable to other jurisdictions.