Declaration of Dividend

8.1 The second proviso to sub-section (1) of Section 123 of the Act provides that, 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 it to the reserves, such declaration of dividend shall not be made except in accordance with the Rules prescribed by the Central Government. Rule 3 of Companies (Declaration and Payment of Dividend) Rules, 2014 specifies the conditions in this regard. It was pointed that as per these provisions, compliance with Rule 3 would be required only when dividend is declared out of ‘reserves’. The said Rule 3 allows declaration of dividend out of ‘free reserves’ only and it is not clear whether a company would be required to comply with the said Rule even when it proposes to declare dividend out of surplus in profit and loss account. The surplus balance (i.e. carried forward balance of profit and loss account) is a part of “free reserves” but it does not represent an amount 'transferred' to reserves. It has been suggested that to avoid any legal challenges in application, the requirements of the Rule and the section should be harmonized appropriately.

8.2 The Committee feels that Rules should use the same language as was provided in the Act. Thus, Rule 3 should provide for conditions only in situations where, in case of inadequacy of profits, the dividend is to be declared out of 'accumulated profits earned by the company in the previous years and transferred by the company to the reserves as has been referred to in the main section of the Act. The Committee discussed and felt that companies must have the freedom of utilizing the balance standing in the Profit and Loss account (not transferred to the reserves) for payment of dividend in case of inadequacy of profit in a year. The Committee felt that once Rule 3 is aligned with the provisions of the Act, it would be clear that in case a company declares dividend out of surplus i.e. accumulated credit balance of Profit and Loss Account which has not been transferred to reserves, the provisions of the Act and Rule 3 would not applicable. The Committee recommended harmonization of Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 and Section 123 of the Act to provide clarity on the issue.

Exemptions from Second proviso to section 123(1)

8.3 Item No. 6 of notification [G.S.R. 463(E)] dated 5 June 2015, provides that the provisions of Chapter VIII and second proviso to sub-section (1) of Section 123 (provisions relating to declaration of dividend in case of inadequacy or absence of profits), shall not apply to a Government Company in which the entire paid up share capital is held by the Central Government, or by any State Government or Governments or by the Central Government and one or more State Governments. It was suggested that this exemption should be extended to non-wholly owned Government companies as well. The Committee felt that such exemption might not be a good practice, especially as some of the companies might be listed also. It noted that such exemption was also not given under the 1956 Act. The Committee, therefore, did not recommend a change.

Declaration of dividend: align rules to apply only where dividends arise from accumulated profits transferred to reserves. The Committee recommends harmonising Rule 3 with the statutory proviso so the rule applies only where dividends are proposed out of accumulated profits earned in previous years and transferred to the reserves, and confirms companies may use the carried forward surplus in the Profit and Loss account for dividend distribution when current year profits are inadequate.