Corporation Tax, Distributable Reserves and Dividend Extraction Ahead of a Sale
Before a business can be sold, its numbers need to withstand scrutiny. Few areas get more scrutiny in due diligence, or cause more last-minute friction, than how profit has historically been extracted, and whether that was done lawfully.
The distributable reserves rule
Under the Companies Act 2006 (s830 onward), a company can only pay a dividend out of “profits available for the purpose.” Broadly, that means accumulated realised profits less accumulated realised losses, as shown in relevant accounts.
A dividend paid without sufficient distributable reserves is unlawful. That’s true regardless of whether the company had cash in the bank to pay it. It’s also true regardless of whether anyone realised there was a problem at the time.
This matters enormously in a sale process. A buyer’s lawyers will review historical dividend payments against the distributable reserves position at the time each was paid. Say they find an unlawful dividend during diligence, however innocently made years earlier. That creates a liability. Someone has to address it, through repayment, or a formal waiver and restatement, before completion. In the meantime, it gives a buyer leverage to renegotiate price.
Corporation Tax and what it leaves available to extract
Corporation Tax planning ahead of a sale operates on a related but separate track. The rate itself shapes how much profit is available to distribute or reinvest in the first place: 25% for profits above £250,000, tapered down to 19% below £50,000, with marginal relief between.
Timing matters too. The timing of capital allowances claims, R&D relief, or loss relief in the run-up to a sale can materially affect two things. First, the company’s reported profitability, which buyers use to value it. Second, how much cash is genuinely available to extract before completion, rather than staying locked inside the company for the new owner’s benefit.
Where the two issues meet
The two issues meet at exactly the point most owners underestimate. Extracting value from a business ahead of a sale — rather than leaving it for the buyer to inherit — has to happen through properly declared, properly documented dividends. That means a demonstrably sufficient reserves position, not an informal one. It can’t happen informally, and owners can’t tidy it up retrospectively once a buyer’s diligence team starts asking questions.
Three things turn an otherwise defensible dividend into one a buyer’s lawyers will actually accept without further negotiation. Interim accounts, prepared specifically to justify a dividend. Board minutes recording the decision. And a clear paper trail showing the reserves calculation at the time.
Frequently Asked Questions
What makes a dividend unlawful in the UK? A company pays an unlawful dividend when it doesn’t have sufficient distributable (accumulated realised) profits to cover it. That’s true regardless of how much cash sits in the bank at the time.
Why do buyers scrutinise historical dividends in due diligence? Because an unlawful dividend, even one paid innocently years earlier, creates a liability. Someone must resolve that liability before completion. And a buyer can use it to renegotiate the sale price.
What is the current UK Corporation Tax rate? 25% for profits above £250,000, tapering down to 19% below £50,000, with marginal relief for profits in between.
How H&Hendricks Can Help
H&Hendricks reviews distributable reserves and historical dividend documentation as a standard part of getting a business sale-ready. We catch issues while they’re still simple to fix, rather than during a buyer’s diligence.
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