PROVISIONS OF COMPANIES ACT REGARDING DIVISIBLE PROFITS
Section 205 of the Act specifies the sources from which dividends can be paid and makes it compulsory for a company to provide for depreciation before declaring dividends. It also lays down the manner of providing for depreciation as well as that of payment of dividends.
Sources of Dividends
Following are the sources from which dividends may be declared:
I. Out of Current Profits
Dividends may be declared out of the profits of the company for the current year after providing for depreciation. However, a company is required to transfer a prescribed percentage of its profits to reserves before declaring dividends. According to the rules framed by the central government in this regard, no dividend can be declared or paid by a company for any financial year out of its profits for that year unless it transfers a percentage of its profits for that year to reserves as follows:
| Proposed dividend | Amount to be transferred toReserves | |
| 1. | Where the proposed dividend exceeds 10 per cent but does no exceed 12.5 per cent of the paid-up capital | Not less than 2.5 per cent of the current profits |
| 2. | Where the proposed dividend exceeds 12.5 per cent but docs not exceed 15 per cent of the paid-up capital | Not less than 5 per cent of the current profits |
| 3. | Where the proposed dividend exceeds 15 per cent but docs not exceed 20 per cent of the paid-up capital | Not less than 7.5 per cent of the current profits |
| 4. | Where the proposed dividend exceeds 20 per cent of the paid-up capital | Not less than 10 per cent of the current profits |
The rules do not prohibit a company from transferring to its reserves a higher percentage of its current profits than that stipulated above. However, it is provided that where a company wishes to transfer more than 10 per cent of its current profits to reserves, it can do after complying certain conditions.
It has been clarified that the term current profits implies profits after tax. The arrears of depreciation should also be provided before arriving at the figure of profits. The term reserves means only free reserves and does not include capital reserve or any special reserve.
Penalty
If a company fails to comply with any of the provisions contained in these rules, the company and every officer of the company in default shall be punishable with fine which may extend to five hundred rupees, and, where the contravention is a continuing one, with a further fine which may extend to fifty rupees for every day, after the first, during which such contravention continues.
II. Out of Past Reserves
The second source of dividends is the reserves created out of the undistributed profits of any previous financial years after providing for depreciation.
The rules regarding declaration of dividend out of reserves provide that in the event of inadequacy or absence of profits in any year, dividend may be declared by a company for that year out of the accumulated profits earned by it in previous years and transferred by it to the reserves, subject to the following conditions: –
1. The rate of the dividend declared shall not exceed the average of the rates at which dividend was declared by the company in the five years immediately preceding that year or 10% of its paid-up capital, whichever is less.
2. The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserves shall not exceed an amount equal to one-tenth of the sum of its paid-up capital and free reserves and the amount so drawn shall first be utilised to set off the losses incurred in the financial year before any dividend in respect of equity shares is declared.
3. The balance of reserves after such withdrawal shall not fall below fifteen per cent of its paid-up share capital.
Steps for Interim Dividend:
1) The Board of Directors, in a meeting of the Board, may decide to declare an interim dividend;
2) The same can be decided on the basis of provisional results for the year, after due consideration among the Board;
3) Transfer of requisite amount needs to be made to “General Reserve” as discussed above.
4) A special Bank account needs to be opened within 5 days of such a Board Meeting where an amount equal to Interim Dividend shall be deposited;
5) Once dividend has been declared in the said Board Meeting, the company must distribute the same within thirty days of its declaration;
6) The company is liable to pay Dividend Distribution Tax @16.225% (15% plus 5% surcharge plus education cess @ 3%). Tax on distributed profits shall be paid within 14 days from the date of declaration, distribution or payment whichever is earlier;
7) Confirm the interim dividend so declared in the next Annual General Meeting by declaring Final Dividend thereat.
Steps for Final Dividend:
1) Board of Directors has a right to recommend the rate of dividend to be declared. But shareholders’ approval in the Annual General Meeting is necessary before any dividends can be declared or distributed.
2) Transfer of requisite amount needs to be made to “General Reserve” as discussed above.
3) A special Bank account needs to be opened within 5 days of adoption of the Board’s recommendation in the AGM where an amount equal to Final Dividend shall be deposited;
4) Dividend once declared in the Annual General Meeting must be paid within thirty days of its declaration.
5) The company is liable to pay Dividend Distribution Tax @16.225% (15% plus 5% surcharge plus education cess @ 3%). Tax on distributed profits shall be paid within 14 days from the date of declaration, distribution or payment whichever is earlier.
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Submitted by :-
Puneet Pal Singh
Vikas Kochhar & Associates
Chartered Accountants
Thanks for this informative article. If possible, you could add further information on withdrawal of a proposal to pay interim dividend based on the Board’s resolution passed earlier. There have been some cases where a Board announces an interim dividend but withdraws the proposal later. The reasons for the withdrawal could be varied (one being to manipulate the share price).