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Implication of negative reserves

Company in profit has paid excess dividends creating negative reserves

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I have prepared the accounts for a small company that has made a profit for the year and has retained earnings brought forward. However, the directors have paid themselves too many dividends, which has created a small (£1.5k) balance of negative reserves. What is the correct treatment of this? Should I credit dividends and debit directors loan account with £1.5k so reserves are nil and there is an overdrawn directors loan account? If so, and the directors agree to repay the 'loan' within 9 months of the year end, do I file a CT600A to show the balance owed? I understand, as the loan is less than £5k, there are no personal tax implications for the directors. Finally, I will have to disclose the overdrawn directors loan account as per FRS102.

I expect this is a fairly common scenario (small company with one or two directors who take too many dividends) and would like to treat the position of negative reserves due to excess dividends correctly.

Thanks in advance for any help and advice.

Replies (63)

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By Wanderer
14th Mar 2017 13:58

If they were paid as dividends why are you proposing to rewrite history?

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By Tim Vane
14th Mar 2017 14:01

You cannot rewrite history. If the dividends are documented then they are dividends, whether illegal or not. If the accounts are to show a true and fair view then they need to reflect reality.

This scenario is not actually that common. In nearly all cases I come across where directors have taken too much cash out they have not actually declared a dividend, so it's simple enough to declare the maximum dividend and push everything through the DLA.

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By CMH
14th Mar 2017 14:09

I would assume the dividends are not formally declared. It is a case of the directors taking cash out. So you are saying that I journal the cash withdrawals through the DLA, declare the maximum dividend to take resreves to nil and then they are left with an overdrawn DLA? Do i need to file a CT600A?

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Replying to CMH:
By Tim Vane
14th Mar 2017 14:25

Right, so there are not actually any dividends, and there are overdrawn loan accounts at the end of the period? Of course you need to file a CT600A. Are you sure you have the experience to handle this client? This is small company 101.

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By Wanderer
14th Mar 2017 14:16

You said that they had paid them as dividends.

If they had why not just leave them as such.

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By Dick Stastey
14th Mar 2017 14:21

You cannot do this. Having negative reserves is illegal.

You will have the overdistribution police beating down your doors in no time at all, and "executing every mother-loving last one of you". Love you Honey Bunny!

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Replying to Dick Stastey:
RLI
By lionofludesch
14th Mar 2017 14:35

Dick Stastey wrote:

Having negative reserves is illegal.

Rubbish.

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Replying to lionofludesch:
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By Dick Stastey
14th Mar 2017 14:57

It seems a bit rich, you, of all people, calling somebody out for talking [***], if I'm being completely honest.

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Replying to Dick Stastey:
RLI
By lionofludesch
14th Mar 2017 15:12

Me of all people ?

Thanks for your view.

Let me know when it became illegal to make a loss.

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Replying to lionofludesch:
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By Dick Stastey
14th Mar 2017 15:14

You're so very welcome.

I take it you're not familiar with the expression, "tongue in cheek"?

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Replying to Dick Stastey:
RLI
By lionofludesch
14th Mar 2017 15:24

It's true that I do make a lot of comedy posts.

But they're better quality .......

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Replying to Dick Stastey:
paddle steamer
By DJKL
14th Mar 2017 15:29

I am sure we're all cool, Honey Bunny, we're still
cool, quality of mercy and all that.

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Replying to DJKL:
RLI
By lionofludesch
14th Mar 2017 16:36

Absolutely.

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Replying to lionofludesch:
Euan's picture
By Euan MacLennan
14th Mar 2017 17:43

Just how narrow do these boxes go?

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Replying to Euan MacLennan:
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By Dick Stastey
14th Mar 2017 17:46

It's difficult to know, at this stage.

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Replying to Dick Stastey:
RLI
By lionofludesch
14th Mar 2017 17:53

I bet it's narrower than this.

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Replying to lionofludesch:
abc
By Kim Jong Un's Hair
15th Mar 2017 00:15

This reply subthread can't be read on a phone... indents to nothing.

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Replying to Kim Jong Un's Hair:
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By nogammonsinanundoubledgame
15th Mar 2017 04:02

Kim Jong Un's Hair wrote:

This reply subthread can't be read on a phone... indents to nothing.


Permit screen rotation and rotate your phone to landscape. Not perfect but gets you some breathing space
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Replying to nogammonsinanundoubledgame:
paddle steamer
By DJKL
15th Mar 2017 10:02

Is narrower possible, or is there a limit?

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:03

Does not appear to be.

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:04

Is this it or can the boundaries be pushed further?

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:05

There appear to be no limit, an infinite reduction into absurdity appears possible.

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:07

Pushing the boundaries of the possible in mankind's quest to discover the strangest website ever, can I get this down to a single line?

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:10

Accounting Web

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Replying to DJKL:
paddle steamer
By DJKL
15th Mar 2017 10:10

Accounting web

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Replying to DJKL:
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By Chipette
15th Mar 2017 10:14

C
A
N
'
T

R
E
A
D
!

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Replying to Chipette:
Stepurhan
By stepurhan
15th Mar 2017 16:02

Chipette wrote:

C
A
N
'
T

R
E
A
D
!


Incredible! Clearly someone thought this change through really well. I wonder if you can completely break the template with a long word.

Floccinaucinihilipilification! (Longest word in the English language)

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Replying to Dick Stastey:
Flag of the Soviet Union
By thevaliant
14th Mar 2017 14:40

I assume this is a comedy reply, because negative reserves are not illegal.

I'd be inclined to leave and move on. After all, I'm quite sure the dividends were drawn down on the basis of firm and robust management accounts suggesting they were legal dividends.

It's just after the year end, the client 'forgot' about that £1,500 invoice that was missing from the management accounts, tipping them to negative reserves.

Looks like Mr Stastey (Is this a play on Richard Milhous Dastardly?) isn't the only one capable of a comedy reply......

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RLI
By lionofludesch
14th Mar 2017 14:22

£1500 is too small to bother with but, if it were larger, I'd include a note that the directors/shareholders/whoever are aware that they've cocked up the dividends and that they may be required to repay them to the company at some point in the future.

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By Ruddles
14th Mar 2017 14:53

One point appears to have been overlooked in all of this - what was the position at the time the dividends were 'declared'?

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By CMH
14th Mar 2017 15:09

Thanks for your point Ruddles. It looks like one of the directors took a 'dividend' of £1.5k without realising the consequences. They keep their own management accounts and present me with a trial balance at the year end. I believe this was an oversight. So do I leave the dividends as they are and show negative reserves? The director has agreed to repay the sum within 9 months of the year end, and so I don't think any up front corporation tax is payable.

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Replying to CMH:
RLI
By lionofludesch
14th Mar 2017 15:23

CMH wrote:

Thanks for your point Ruddles. It looks like one of the directors took a 'dividend' of £1.5k without realising the consequences.

"One of the directors" took a dividend ??

So were these "dividends" not paid in proportion to the shareholdings ?

Which begs the question as to whether they were dividends in the first place.

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Replying to lionofludesch:
RLI
By lionofludesch
14th Mar 2017 16:41

lionofludesch wrote:

CMH wrote:

Thanks for your point Ruddles. It looks like one of the directors took a 'dividend' of £1.5k without realising the consequences.

"One of the directors" took a dividend ??

So were these "dividends" not paid in proportion to the shareholdings ?

Which begs the question as to whether they were dividends in the first place.

Your reply to this query is crucial to deciding whether the payments were dividends in the first place.

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Replying to CMH:
By Ruddles
14th Mar 2017 16:28

That didn't answer my question - which is, regardless of the position at the year-end, were there sufficient reserves at the time of declaring the dividend? (Although in view of previous and later comments, it seems doubtful that dividends were properly declared in the first place.)

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By CMH
14th Mar 2017 15:11

One other thought, as a more general query, if the director is charged interest on the loan (3% I think it the rate) does this all go away?

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Replying to CMH:
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By Dick Stastey
14th Mar 2017 15:15

What loan?

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Replying to CMH:
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By Discountants
14th Mar 2017 15:22

CMH wrote:

One other thought, as a more general query, if the director is charged interest on the loan (3% I think it the rate) does this all go away?

It removes the need to file a P11d if the balance is more than 10k during a tax year.
That is all it does - s455 would still be due if it, or a part of it, is unpaid at the point the CT is due.
All other reporting requirements remain the same.

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By Discountants
14th Mar 2017 15:19

Ruddles point is the most important IMO

If there were enough funds available to distribute at that point then there is nothing wrong with these dividends.
The situation is identical to a company which makes profit in one year, distributes said net profits and then makes a loss the next year. The loss (and resulting negative funds available) do not cancel the previous year's dividends, they simply result in more profits needing to be made in future before the shareholders can extract more.

I feel differing issues cloud this issue and they are very relevant to how most of our smaller clients actually seem to do things :(

HMRC may challenge these dividends and say that this should go to DLA with any appropriate s455 tax (if any) due. However this will greatly depend on the following:

1. Were these dividends properly declared and at least an estimation done of an up-to-date balance sheet before they were declared.
2. Did the deficit in funds result because of a short loss-making period between the last dividend declared and the end of the accounting period.

If both of the above apply HMRC has no justification to try to state the excess should go to DLA.
If they do not then you should look and see if _any_ of the dividends were properly declared and, if not, if they should now be classified as DLA with, hopefully a dividend being declared now to clear any overdrawn DLA - said dividend may end up being in a different tax year to the one in which they withdrew the funds, something which may impact on the tax-efficiency of these dividends.

Edit: lol the perils of writing an essay on a hot topic :)

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By Dick Stastey
14th Mar 2017 15:29

WHAT LOAN???

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Replying to Dick Stastey:
By Ruddles
14th Mar 2017 16:31

The debt that might exist as a consequence of a director having withdrawn funds from his company without a dividend (or bonus ...) having been declared, if that is in fact what happened - no-one seems to have a clue as to what happened.

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Replying to Ruddles:
RLI
By lionofludesch
14th Mar 2017 16:45

Agree - the OP seems to want a definitive answer without actually disclosing any of the facts.

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By JCresswellTax
14th Mar 2017 15:46

What an absolute mess of a very simple situation!

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By CMH
14th Mar 2017 16:25

JCresswell Tax - thank you! Can you please add a simple solution to this simple situation?

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Replying to CMH:
By JCresswellTax
14th Mar 2017 16:28

Ok.

If the funds are drawn as dividends, treat them as dividends.

If the funds are drawn as loans, treat them as loans.

If there are outstanding loans at year-end, record them on CT600a.

If there are no outstanding loans at year-end, only negative reserves, do not report on CT600a.

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By CMH
14th Mar 2017 17:23

Thanks J Cresswell, but I suppose I come back to my original position of illegal dividends (dividends in excess of distributable reserves), and how HMRC require them to be treated, if they are not classed an an overdrawn DLA?

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Replying to CMH:
RLI
By lionofludesch
14th Mar 2017 17:35

How about answering the question as to whether these are properly declared dividends, in proportion to the shareholdings, before we move on to consider something which may be wholly irrelevant?

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Replying to CMH:
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By Wanderer
14th Mar 2017 17:36

IF & it is an IF they are illegal:-
https://www.gov.uk/hmrc-internal-manuals/company-taxation-manual/ctm20095

but don't just assume that because they are in excess of distributable reserves at the year end that they were / are illegal.

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Replying to Wanderer:
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By Dick Stastey
14th Mar 2017 17:47

That guidance has to be incorrect, a person cannot simultaneously be both a trustee and a debtor in relation to the same sum of money.

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Replying to Dick Stastey:
paddle steamer
By DJKL
15th Mar 2017 09:42

An interesting variant akin to Schrödinger's cat, it only resolves when we open the box. (determine the facts)

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Replying to CMH:
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By Jack Spratt
14th Mar 2017 17:43

Nobody has framed the key question about the "dividends". Were there minutes of the directors declaring them before or at the time they were paid? If not then they were not dividends. They were advances (or loans) to the directors.
Later minutes might have declared dividends which might have cleared the loans.
If you can sort that out you then have a figure for dividends and HMRC will want and be entitled to tax on those dividends regardless of whether they were illegal or not.
If they were illegal (ie not paid from distributable reserves) that does not stop them being taxable. But there are implications should the company go bust or similar.

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