Summary: The payment of dividends by companies in India is governed by Section 123 of the Companies Act, 2013, alongside the Companies (Declaration and Payment of Dividend) Rules, 2014. Dividends may be paid from current year profits after depreciation, past profits, or government funds. Companies must first offset any carried-over losses and depreciation from previous years against current profits before declaring dividends. Depreciation must also be accounted for as per Schedule II of the Act. When profits are insufficient, dividends may be declared from free reserves, adhering to specific conditions: the dividend rate must not exceed the average of the past three dividends, the total amount cannot surpass one-tenth of the paid-up capital plus free reserves, and the remaining reserves must exceed 15% of the last audited paid-up capital. Free reserves, as defined in Section 2(43) of the Act, are the amounts available for distribution as dividends and exclude unrealized gains and revaluation amounts. The Act does not specify a maximum dividend amount; however, dividends paid from profits are unrestricted barring any internal company limitations, while those from reserves must comply with the outlined rules.
Introduction:
The provisions of the payment of Dividend are provided under section 123 of the Indian Companies Act, 2013. In addition to this the Companies (Declaration and Payment of Dividend) Rules, 2014 shall also be considered.
As per section 123 of the Companies Act, 2013
Dividend Shall be paid
- Out of Current Year Profit after the Depreciation
- Previous Year Profits but after Depreciation
- Money provided by Government for payment of dividend
The following should be considered –
1. Company may transfer any portion or percentage of its profit to Reserves. However, transfer is not mandatory.
2. No dividend shall be declared or paid by a company from its reserves other than free reserves;
3. 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 for the current year.
4. Before any dividend can be paid out of profits of any financial year, a company is required to provide depreciation as per the provisions of the Schedule II of the Companies Act 2013.
Further there shall be nothing in the Articles of Association of the company prohibiting their distribution of the dividends or limiting the amount of the dividend to be paid.
Declaration of Dividend out of Reserves
As per Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014, when there is inadequacy or absence of profits in any year, a company may declare dividend out of free reserves. However, the following conditions to be satisfied –
- The Rate of Dividend = Dividend shall not exceed the average of past three declared dividends. (if first year, this rule shall not apply)
- Maximum Amount to be Drawn = Amount shall not exceed 1/10th of Paid up share Capital + Free Reserves.
- The Amount must be first used to set off current year losses.
- After Dividend Paid the Balance Reserves shall be > 15% of Paid up Capital as appearing in last audited Balance Sheet.
Thus, Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 provides provisions for the following in case the dividend is paid out of Reserves of the Company –
- Rate of the dividend to be paid;
- Limit of the amount that can be withdrawn from the reserves; and
- The Required Remaining Balance of the Reserves after the payment of dividend.
There are no special provisions that state the limit of the maximum amount of dividend that can be paid by a company in India, however the following can be established form the above provisions –
1. When Dividend is paid out of Profit – The company can pay any amount of dividend when such dividend is paid out of the profit of the current or previous years (after making provisions for depreciation and setting off carried forward losses), if no restriction is provided under the Articles of Association of the company.
2. When Dividend is paid out of Reserves – The company shall comply with the provisions of Rule 3 of Companies (Declaration and Payment of Dividend) Rules, 2014 (which provides for rate of dividend, maximum about of withdrawal from the reserves and minimum balance to be maintained before the dividend is declared and distributed.
Note –
Free Reserves under Companies act 2013
Free reserve as defined under Companies act, 2013 is as follows,
Section 2(43) ―free reserves means such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend.
Provided that— (i) any amount representing unrealised gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or (ii) any change in carrying amount of an asset or of a liability recognised in equity, including surplus in profit and loss account on measurement of the asset or the liability at fair value, shall not be treated as free reserves;
In simple words, free reserves means such reserves which are available for distribution as dividend. The reserves amount as per the latest audited balance sheet of a company is taken for consideration.
However, any amount representing unrealised gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise and any change in carrying amount of an asset or a liability recognized in equity, including surplus in profit and loss account on measurement of the asset or liability at fair value. Thus, capital reserves, revaluation reserves, debenture redemption reserves, securities premium and statutory reserves do not form a part of free reserves.
There is no mandatory requirement under Companies Act, to transfer a specific amount to free reserve.
Dividend paid from reserves
Proviso, section 123(1) gives an option to the company to transfer any amount of its profit towards reserves. Proviso reads as follows –
“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”
Sorting of losses from the reserves before declaring dividend
As per the provisions of Rule 3(3) of the Companies (Declaration and Payment of Dividend) Rules, 2014, dividend shall not be declared before any loss of the financial year is set off. The section reads as follows –
“Rule 3(3)“The amount 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 declared.”
Author Bio
