SUBJECT: COMPANY LAW-II’

MODULE: IV
TOPIC: DIVIDEND AND DIVISIBLE PROFIT

Dividend is generally paid on two types of instruments viz.

1. Preference shares – at fixed percentage

2. Equity shares – at rate decided by board

As per section – 2(35) of Companies Act, 2013 dividend is defined as “dividend

includes any interim dividend”.
After enactment of Companies Act, 2013, the concept of payment of dividend is very
liberalized. This is because when we compare the provisions of Companies Act,
1956 with the provisions of Companies Act, 2013 various relaxations regarding
payment of dividend are provided in Companies Ac, 2013 Act.
In this article, we will discuss various provisions provided in section – 123 related to
dividend under Companies Act, 2013.
Lets starts with section – 123(1) of Companies Act, 2013 which provides that no
dividend shall be declared or paid by a company for any financial year except—
(a) out of the profits of the company for that year arrived at after providing for
depreciation in accordance with the provisions of sub-section (2), or out of the profits
of the company for any previous financial year or years arrived at after providing for
depreciation in accordance with the provisions of that sub-section and remaining
undistributed, or out of both; or                
(b) out of money provided by the Central Government or a State Government for the
payment of dividend by the company in pursuance of a guarantee given by that
Government:            
Provided 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:
Provided further 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 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:
Provided also that no dividend shall be declared or paid by a company from its
reserves other than free reserves.
Provided also that 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
Analysis
In simple, dividend can be paid out of the profits of current year or previous years or
both. Let say if company incurred losses in current year even then it can distribute
dividend if it has profit remaining undistributed in previous years. Further if the
company has negative balance in profit and loss account in the beginning of current
year and company earns profit in current year but that profit is insufficient to cover
the losses of previous year (i.e. profit and loss account shows negative balance after
accounting the profit of current year) even then dividend can be distributed out of the
profit earned during current year. In nutshell, if company earned profit in any year
preceding the current year or in current year, than that profit can be distributed as
dividend irrespective of losses incurred by company in any of the year. However that
profit must be kept intact in profit and loss account. In other words, if profit is
transferred to reserve than second proviso to section – 123(1) will apply. Further, for
working out the profit for dividend purpose, depreciation must be provided in
accordance with the provisions of schedule II. The provision of depreciation for
working out the profits is must in Companies Act, 2013. However in Companies Act,
1956 central government was conferred with the power to allow payment of dividend
without providing depreciation. Further, additional depreciation which has to be
provided only because of revaluation of assets is permitted to be transferred to
Statement of profit and loss account. So due regard is given to depreciation in
Companies Act, 2013…. this may be to protect the interest of lenders.
In Companies Act, 1956, it was mandatory to transfer the profit to general reserve
before declaring dividend but first proviso to section – 123(1) of Companies Act,
2013 provides that it is the discretion of the company to transfer the profits to reserve
at such rate as it deems fit before declaring dividend.
However, although it is not mandatory to transfer the profit to reserve, it may be
noted that section – 134 of Companies Act, 2013 requires the board of director to
make the statement that will provide the particulars of amount, if any, the company
proposes to carry to its reserve. Further section – 135(3)(c) and section – 135(5)
requires the board of directors to file directors’ responsibility statement. Therefore
while board of directors now have discretion of transferring the profit to reserves,
they will have to exercise this discretion responsibly and in the best interest of
company.
So, except for providing depreciation before declaring dividend, the concept of
dividend is fully liberalized, which proved as legislative and judicial benediction to
corporate sector.
Second proviso to section – 123(1) provides that if company intends to declare
dividend out of reserves because of inadequacy or absence of profit in any financial
year, than it can do so subject to rules made by central government in this behalf.
It is however be noted that this proviso is an exception to general rule that dividend
can only be declared out of profits (i.e. profit and loss account) which means
company can declare dividend from source other than profits (i.e. reserve). Further, if
there is an inadequacy or absence of profits and company intends to declare
 dividend out of reserves only then rules made by central government will apply. It
seems that if there is no inadequacy or absence of profit even then dividend can be
declared out of the reserves because second proviso is an exception and in that
case rules will not apply. This opinion is further warranted by the phrase used in the
Act i.e. ‘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’. Following the principle of ‘Substance Over Form’ the balance of the
reserve is actually the accumulated profits of the company and dividend can be
declared out of profits. Therefore the matter is debatable.
The analysis of rules made by central government in pursuance of power conferred
to it in second proviso to section – 123(1) is given below:-
 Rule No. 3(1) provides that 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 preceding financial year.
 Rule No. 3(2) provides that 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.
 Rule No. 3(3) provides that 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.
 Rule No. 3(4) provides that 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.
           (Note:- Rule – 5 was omitted by Companies (Declaration and Payment of
Dividend) Second Amendment Rules, 2015)
Third proviso to section – 123(1) provides dividend can only be declared out of free
reserve. Example:- Dividend cannot be declared out of revaluation reserve.
Fourth proviso to section – 123(1) was inserted by Companies (Amendment) Act,
2015 which provides that dividend can only be declared when carried forward
previous losses and depreciation not provided in previous year/s are set off against
the profit of the company in current year.
Section – 123(2) provides that for the purposes of clause (a) of sub-section (1),
depreciation shall be provided in accordance with the provisions of Schedule II.
Section – 123(3) provides that the Board of Directors of a company may declare
interim dividend during any financial year out of the surplus in the profit and loss
account and out of profits of the financial year in which such interim dividend is
sought to be declared:
Provided that in case the company has incurred loss during the current financial year
up to the end of the quarter immediately preceding the date of declaration of interim
dividend, such interim dividend shall not be declared at a rate higher than the
average dividends declared by the company during the immediately preceding three
financial years.
Analysis
 Section – 2(35) provides that “dividend” includes any interim dividend. This definition
was first provided by Companies (Amendment) Act, 2000. Before Companies
(Amendment) Act, 2000, payment of dividend on interim basis was provided in article
– 86 of Table A of Companies Act, 1956 and it has been a practice with the
companies to pay interim dividend. And may be due to this reason, dividend was
defined to include interim dividend under Companies (Amendment) Act, 2000.
Before Companies (Amendment) Act, 2000, dividend can be paid on interim basis if
so authorized by articles. However, in terms of section – 205(1A) of Companies Act,
1956 and section – 123(3) of Companies Act, 2013, the power to declare dividend on
interim basis is statutorily conferred on the companies and now there is no need of
power in Articles of Association to declare interim dividend.
Likewise final dividend, interim dividend should also be paid out only from profits.
The payment of interim dividend is the discretion of board. The board should have to
give due regard to adequacy of profits remaining after provision of depreciation while
exercising its discretion for payment of interim dividend.
Further proviso to section – 123(3) provides that interim dividend cannot be paid at
the rate higher than the average rate of dividend declared in 3 preceding financial
year if company incurred losses during current financial year up to the end of last
quarter preceding the date of interim dividend.
Section – 123(4) provides that the amount of the dividend, including interim dividend,
shall be deposited in a scheduled bank in a separate account within five days from
the date of declaration of such dividend.
Analysis
In case of final dividend, the amount of dividend declared should be deposited in
scheduled bank in separate account within 5 days from the date of declaration of
dividend by members in general meeting and in case of interim dividend, the amount
of interim dividend declared should be deposited in scheduled bank in separate
account within 5 days of declaration of dividend by board in board meeting.
Section – 123(5) provides that no dividend shall be paid by a company in respect of
any share therein except to the registered shareholder of such share or to his order
or to his banker and shall not be payable except in cash:
Provided that nothing in this sub-section shall be deemed to prohibit the
capitalization of profits or reserves of a company for the purpose of issuing fully
paid-up bonus shares or paying up any amount for the time being unpaid on any
shares held by the members of the company:
Provided further that any dividend payable in cash may be paid by cheque or
warrant or in any electronic mode to the shareholder entitled to the payment of the
dividend.
Analysis
This section provides that company should pay dividend only to
 shareholder of such share registered with company or
 the person to who the registered shareholder requires or
 the banker
 This section further provides that dividend can only be paid in cash i.e. it cannot be
paid in kind.
First proviso to section – 123(5) provides that company may issue fully paid-up
bonus shares out of the profits or reserves of the company without any restriction. It
further provides that profits and reserves can be capitalized for paying up any
amount which is, for the time being, unpaid on any shares held by the members of
the company.
Second proviso to section – 123(5) provides that dividend can be paid only through
 cheque or
 warrant or
 in electronic mode
Electronic mode for payment of dividend was not provided in Companies Act, 1956
in fact that was DCA circular under which the payment of dividend in electronic mode
was provided.
Section 123(6) provides that a company which fails to comply with the provisions of
sections 73 and 74 shall not, so long as such failure continues, declare any dividend
on its equity shares.
Section – 73 contains the provisions regarding deposits accepted by private
company from its members and section – 74 contains the provisions regarding
deposits accepted by company before 1st April, 2014.