Declaration and Payment of Dividend-II

Sources out of which dividend may be declared
No dividend shall be declared or paid by a company for any financial year except out of—

• profits of the company for that year arrived at after providing for depreciation (current profits),or
• profits of the company for any previous financial year or years arrived at after providing for depreciation and remaining undistributed (past profits remaining undistributed), or 
• both (current profits and past profits remaining undistributed), or 
• money provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by that Government.

Depreciation has to be provided in accordance with Schedule-II to the Companies Act,2013
Entire past unabsorbed losses need to be set off before dividend is declared

The Companies Act,1956 Act  required that the company shall not declare dividend unless it has provided, in respect of each previous financial year, the loss for that year (after providing for depreciation) or the amount of depreciation provided, whichever is lower.

Example

Year	Profit/(loss) before depreciation (Rs)	Depreciation (Rs)	Profit/(loss) after depreciation (Rs)
2011-12	(100)	25	(125)
2012-13	5	25	(20)
2013-14	28	30	(2)
2014-15	200	30	170

In terms of the provisions of the 1956 Act, the company can declare dividend for 2014-15 only after setting off for each past year amount of loss or depreciation whichever is less. Thus, the following amounts are to be set-off.

Year	Amount to be set-off before declaring dividends(Rs)	Remarks
2011-12	25	Depreciation is lower than the amount of loss.
2012-13	20	Loss is lower than depreciation
2013-14	2	Loss is lower than depreciation
Total	47

Thus, under the 1956 Act, the company needed to set off only Rs 47 out of the Rs147 unabsorbed losses and depreciation from its profit of 2014-15( Rs170) before declaring dividend and company’s divisible profits would be Rs 23. This is against the concept of prudence which demands that the entire unabsorbed loss and depreciation of past years of  Rs 147 be set off against profits of 2014-15 before a dividend is declared and accordingly divisible profits should be only Rs.23. There is no reason why the unabsorbed losses should be set off only to the extent of the unabsorbed depreciation and rest of the unabsorbed losses should not be set off.

The 2013 Act is silent on this issue. Section 123 of the 2013 Act does not contain provisions along the lines of clause (b) of the first proviso to section 205(1) of the 1956 Act. However, Rule 3(5) of the Companies (Declaration and Payment of Dividend) Rules, 2014 notified under the 2013 Act seeks to remedy the situation. Accordingly Rule 3(5) provides that no company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against the profit of the company for the current year. In the above example, under the 2013 Act, entire Rs 147(unabsorbed losses) will have to be set off and divisible profits will be only Rs.23.  The 2013 Act is stricter in this regard. It requires setting off of the entire amount of arrears of unabsorbed depreciation and losses (and rightly so) and not merely the lower of the loss after depreciation and depreciation


Only free reserves to be used for declaring dividends
No dividend shall be declared or paid by company from its reserves other than free reserves [Third proviso to section 123(1)].

Definition of free reserves
Section 2(43) of the 2013 Act defines ‘free reserves’ to mean such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend.

The following shall not be regarded as free reserves and shall not be available for distribution as dividend :

• unrealized gains, whether shown as reserve or otherwise 
• notional gains, whether shown as a reserve or otherwise 
• amount representing revaluation of assets, whether shown as reserve or otherwise.
• any change in carrying amount of an asset or liability recognized in equity, including surplus in P&L account on measurement of assets or liability at fair value.

Transfer of amounts to reserves is optional [First Proviso to section 123(1)]
The first proviso to section 123(1) provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves of the company. There is no requirement along the lines of the 1956 Act to transfer specified percentage of profits before declaring dividend if dividend rate exceeds a specified percentage. The 956 Act which provided for compulsory transfer of prescribed percentage of profits to reserves before declaring dividends at a rate exceeding 10% of paid-up capital.

Declaration of dividends out of accumulated past profits transferred to reserves [Second proviso to section 123(1)].
Where, owing to inadequacy or absence of profits in any financial year, any company proposes to declare dividend out of the accumulated profits earned by it in previous years and transferred by the company to the
reserves, such declaration of dividend shall not be made except in accordance with such rules as may be prescribed in this behalf. [Second proviso to section 123(1)].
Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 titled ‘Declaration of dividend out of reserves’ provides that in the event of inadequacy or absence of profits in any year, a company may
declare dividend out of free reserves subject to the fulfillment of the following conditions, namely:—

• The rate of dividend declared shall not exceed the average of the rates at which dividend was declared by it in the three years immediately preceding that year. (The above limit on rate of dividend shall not apply to a company, which has not declared any dividend in each of the three preceding financial years).
• The total amount to be drawn from such accumulated profits shall not exceed one-tenth of the sum of its paid-up share capital and free reserves as appearing in the latest audited financial statement.
• The amount so drawn shall first be utilised to set off the losses incurred in the financial year in which dividend is declared before any dividend in respect of equity shares is declared. 
• The balance of reserves after such withdrawal shall not fall below fifteen per cent of its paid up share capital as appearing in the latest audited financial statement. 
• No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against profit of the company of the current year.