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Accounting for capital loss and dividends

I am hoping someone can help me with the following query:

There are two companies, A and B. Both are owned 100% by the same director/ shareholder. Company B then buys the shares in Company A at an arms length valuation of £20,000. Six months later Company A ceases to trade and is effectively worthless.

We are drawing up the first year's accounts for Company B. It has accounted for the share purchase as Debit Fixed Asset Investment £20,000, Credit Other Creditors £20,000. Then, it recognises the loss and enters: Dr Loss on Investment (P&L) £20,000, Cr. Fixed Asset Investment £20,000.

If you ignore the above, and tax, the company has otherwise made a profit of £50,000 and the director/ shareholder has extracted £40,000 as a dividend. BUT...once you take into account the loss on the shares the reserves are "only" £30,000 so the dividends are illegal.

The question there a way in the accounts to treat the £20,000 as a capital loss separate to the distributable reserves so the dividends are not illegal? Adding the loss back in the tax computation and showing it as a capital loss is great for the tax return but doesn't help with the accounts! I could show it as an exceptional item, but IRIS seems to automatically take it out of distributable reserves anyway so I am back to square one.

Is there a way for IRIS to somehow show it "below the line" so the dividends do not look illegal? Or can - or should - the £20,000 be shown as a capital distribution somehow ? Or should I call the £20,000 a "negative capital reserve" on the balance sheet, which sounds and is ridiculous as far as I can see! 

I would appreciate any help with this.  


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IRIS is right

If in doubt about the correct accounting (or tax) treatment, run it through IRIS and see what IRIS reports - then when you know the answer, justify it back to the legislation.  The loss on the investment (and one has to question the arm's length valuation only 6 months earlier) has to be charged to the P&L.  There can be no separate capital loss or negative capital reserve in this situation.

However, I am confused by the facts stated.  If the director owned 100% of Company A, Company B's "Other Creditors" must be the director.  So, you could say that the £40,000 which Company B has paid to the director is comprised of £20,000 in payment for his shares in Company A and dividends of £20,000 out of profits of £30,000, which is entirely legal.

What's the problem or am I missing the point?

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