The Permitted Sources
Section 123(1) permits a dividend to be declared or paid for a financial year out of: the profits of the company for that year after providing for depreciation in accordance with Schedule II; the profits of any previous financial year or years after providing for depreciation, and remaining undistributed; or both. The source hierarchy matters: current-year profits are the primary source, and accumulated profits are available only after the depreciation adjustment.
The Loss-Year Condition
Where the company has incurred a loss in the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, the rate of dividend cannot exceed the average of the rates at which dividend was declared in the three immediately preceding financial years. The condition applies to interim dividend and requires a quarter-by-quarter computation of the loss position.
The Rule 3 Conditions for Reserves-Based Dividend
Where a company proposes to declare dividend out of accumulated profits transferred to free reserves, Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 imposes additional conditions: the rate cannot exceed the average of the three preceding years; the total amount drawn from reserves cannot exceed one-tenth of the sum of paid-up capital and free reserves; the amount drawn must first be used to set off losses; and the balance of reserves after withdrawal cannot fall below fifteen per cent of the paid-up capital. These conditions are cumulative.
The Payment Mechanics
Section 123(4) requires the dividend amount, including interim dividend, to be deposited in a separate bank account within five days from the date of declaration. Section 123(5) requires payment to the registered shareholder or the shareholder’s order or banker, and prohibits payment in kind except in specified cases. The payment timeline is thirty days from the date of declaration, and a failure attracts Section 127 consequences.
Documentation for the Dividend File
The file should contain: the board resolution recommending the dividend; the AGM resolution declaring it; the profit and reserve computation; the Rule 3 working where applicable; the separate bank account confirmation; the payment register; and the unpaid dividend transfer working. A dividend declared without the source computation and the Rule 3 working is vulnerable to a challenge that it was paid from an impermissible source.
Call to Action: For dividend source verification, Rule 3 computation, or dividend documentation review, contact office@anujdesaiassociates.com or 9619456656. Website: https://anujdesaiassociates.com. LinkedIn: linkedin.com/in/ca-anuj-desai-122547230.