Yes, prima facie, it is possible for a company to pay dividend out of reserves.

In advance India, majority of the people are investing in the shares of those companies which are regularly paying dividends. Everybody, who invests expect a healthy return from such investment. The large companies which are regularly paying dividends are becoming big fascination for the people who expects the regular return from their investments.

As per Second proviso of sub-section (1) of section 123 of Companies Act, 2013, 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 free reserves, such declaration of dividend shall not be made except in accordance with such rules as may be prescribed in this behalf.

As per Rule 3 of Companies (Declaration and Payment of Dividend) Rules, 2014

dividends on virtual screen. Business, technology and internet concept

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 following conditions, namely –

(1) 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

Provided that this sub-rule shall not apply to a company, which has not declared any dividend in each of the three immediately financial year.

(2) 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.

(3) The amount so drawn shall first be utilized to set off the losses incurred in the financial year in which dividend is declared before any dividend in respect of equity shares is

(4) 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.

Let us analyse the above concept:-

It has been clarified that even in the absence of required profits for dividend, company may at its discretion pay dividend, but only out of free reserves of the company that too after fulfillment of all the following conditions –

  • Condition 1: In any case, rate of dividend shall not exceed the average rate of dividend paid in three immediately preceding financial years, and if not paid in any of the three preceding financial years, than it will be considered as zero foe that year. But if dividend is not paid in all the three preceding financial years, than this condition shall not apply and rate of dividend can be determined by the company itself.

Example: X Ltd. wants to pay dividend in F.Y. 2020-2021. What shall be the maximum rate it can pay if it has paid dividend in 2017-18 at 11%, 2018-19 at 14% and 2019-20 at 0%?

Average rate of three years rate = (11+14+0)÷3 = 8%.

  • Condition 2: The maximum amount that can be withdrawn from the reserves shall be 10% of sum of paid up share capital (both equity and preference) and free reserves taken together.

In the above example, if paid up equity share capital is Rs. 1000 crore, paid up preference share capital is Rs. 500 crore and free reserves amounts to Rs. 500 crore, all summed up as Rs. 2000 crore. Now, maximum amount that can be withdrawn from free reserves will be Rs. 200 crore (10% of 2000 crore).

  • Condition 3: The amount so withdrawn shall first be utilized for set off the losses of the current financial year if any before paying dividend on equity shares.

If in the above example, company has been in losses of Rs. 20 crore in F.Y. 2020-21, than the amount so withdrawn i.e. Rs. 200 crore shall be deducted by losses of Rs. 20 crore, and only Rs. 180 crore can be paid as equity dividend in F.Y. 2020-21.

  • Condition 4: After withdrawal of such amount from reserves, the balance of free reserves shall not fall below 15% of paid up share capital of the company.

Now, if we continue the above example, the opening balance of free reserves was Rs. 500 crore, and withdrawal was of Rs. 200 crore. So, the closing balance of free reserves, i.e. after withdrawal of amount for payment of dividend, will be Rs. 300 crore (500-200). The balance that shall be maintained in free reserves is Rs. 225 crore (15% of 1500 crore, i.e., sum of paid up equity share capital and paid up preference share capital). So, this condition has also been fulfilled, and X. Ltd. can pay the maximum dividend of Rs. 180 crore.

It can be concluded that dividend which is to be paid by the company can be paid out of current year profits or previous year profits or even from reserves, but only after complying with the prescribed conditions.

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Disclaimer: The contents of this article are for information purposes only and does not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author / TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

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