What is Statutory Reserve?
A statutory reserve is a portion of a company’s annual net profit that the law requires it to retain rather than distribute to shareholders. The reserve strengthens the company’s equity base, protects creditors, and absorbs future losses. It is mandatory and cannot be reduced below the threshold defined by the local Companies Law.
How It Works
- At each year-end, the company calculates its net profit after tax and zakat.
- A fixed percentage is transferred from retained earnings to the statutory reserve account in equity.
- Transfers continue every year until the reserve reaches a regulated cap, often a percentage of paid-up capital.
- The reserve cannot be paid out as dividends, but it can be used to offset accumulated losses or to issue bonus shares under specific conditions.
Saudi Context
Under the Saudi Companies Law, joint-stock and limited liability companies must transfer 10% of annual net profit to the statutory reserve until it reaches 30% of paid-up capital. ZATCA does not allow this reserve to reduce taxable income, but it is a key item in equity disclosures for any Saudi company.
Example
A Saudi LLC reports SAR 2,000,000 net profit. It transfers SAR 200,000 (10%) to the statutory reserve. After several years, the reserve hits 30% of the company’s SAR 5,000,000 capital, so no further transfers are required.