What is Legal Reserve?
The legal reserve is a statutory equity reserve required by company law, funded by appropriating a fixed percentage of annual net profit until it reaches a defined threshold of share capital, and generally non-distributable to shareholders.
How It Works
- Funded by appropriating a fixed percentage of net profit each year.
- Continues until reaching the legal threshold (30% of share capital in Saudi Arabia).
- Non-distributable as dividends but can be capitalized via bonus shares.
- Used to absorb losses before any other reserves are touched.
Saudi Context
The Saudi Companies Law mandates that joint-stock and limited-liability companies transfer 10% of annual net profit to the legal reserve each year until the cumulative balance equals 30% of paid-up share capital. Once the threshold is met, further transfers become optional and the reserve can no longer absorb dividend pressure.
Example
A Saudi LLC with SAR 1,000,000 share capital earns SAR 500,000 net profit. It transfers SAR 50,000 (10%) to the legal reserve. After 6 profitable years averaging this transfer, the reserve reaches SAR 300,000 (30% of capital) and the appropriation stops.