SECTION 205
DIVIDEND TO BE PAID ONLY OUT
OF PROFITS
Dividend declared at
extraordinary general meeting of company - Whether permissible
The query has been raised whether a company is
prohibited from declaring a further dividend at a general meeting of a company
other than the annual general meeting after a dividend had already been
declared at an annual general meeting.
Such a situation could arise, for example, when after declaring a
dividend at an annual general meeting, the company finds that it is required to declare a further amount as dividend
in order to qualify for certain benefits under the Income-tax Act.
The matter has been considered in the Company Law
Board which has been advised that while there is no provision in the Companies
Act prohibiting the declaration of a dividend at a general meeting other than
the annual general meeting of the company (vide regulation 85 of Table A
of Schedule I) unless otherwise
provided in the articles of association, it is beyond the powers of a company
to declare a further dividend after the declaration of dividend at the annual
general meeting. In this connection
attention is invited of all concerned, to the decision of the Calcutta High Court
in the matter of Biswa Nath Pd. Khaitan
v. New Central Jute Mills Ltd. (1961) 31 Comp. Cas. 125. Thus a company which could not declare a
dividend at an annual general meeting may do so at a subsequent general
meeting. On the other hand, where a company
has declared a dividend at a general meeting neither the company nor its
directors can declare a further dividend for the same year.
*
CIRCULAR NO.22[7/9/74-CL-ii], DATED 25.9.1975.
Payment of interim dividend
-Whether confirmation by shareholders has to be only in annual general meeting.
Approval of dividend is the privilege of the general
meeting and the board can pay interim dividend if so authorised by the articles
of association subject to the regularisation of the interim dividend by the
company in general meeting. The general
meeting for this purpose can be annual general meeting only, for the profit for
the financial year would not otherwise be known.
*
LETTER NO. 8/13(205A)/79-CL-V, DATED 18.7.1981.
Clarifications
on the provisions relating to depreciation under the Companies Act, 1956, as
amended by the Companies (Amendment) Act, 1988.
This Department has been receiving queries from different
quarters on the subject mentioned above, from time to time, and, accordingly,
the following clarifications are issued:-
1) Date on which the new provisions relating to
depreciation become effective:
The Companies (Amendment) Act, 1988, specifically
provides that Schedule XIV shall be deemed to have come into force on 2nd
April, 1987. The amended provisions of
sections 205 and 350 of the Act have come into force on 15th June, 1988, by
virtue of the notification issued by this Department. A question arises, therefore, whether depreciation can be charged
on assets on the basis of the rates provided in Schedule XIV for accounting
years ending between 2nd April, 1987, and 14th June, 1988.
In view of the intention of the Legislature behind
the amendments in sections 205 and 350 of the Act, the amended provisions have
come into force with effect from 2nd April 1987.
2) Recomputation of specified period:
It is stated that in 1986, the Department had issued
a circular stating that specified period once determined may not be
recomputed. Accordingly the Department
had advised the companies that it was open to them not to recompute the
specified period even when there is a change in the rates of depreciation later
on (as against the position of the Department's earlier circular of 1985 on the
subject). It is argued that as far as
the existing assets are concerned, the companies can follow either of the two
circulars. An option under the 1986
circular would thus be available to the companies as at present not recomputing
the specified period where the Straight Line Method (SLM) is used. In other words, where a company decides to
follow the 1986 circular, assets on which SLM depreciation was being charged,
can continue to be depreciated at the old SLM rates.
In view of this Department's Circular No.1 of 1986
(No.1/1/86-CL-V), dated 21st May, 1986,
specified period once determined may not be recomputed. The companies which follow this circular
may, therefore, continue to charge depreciation at the old SLM rates in respect
of the assets already acquired against which depreciation has been provided in
earlier years on SLM basis.
3) Can higher rates of depreciation be charged.
It is stated that Schedule XIV clearly states that a
company should disclose depreciation rates if they are different from the
principal rates specified in the Schedule.
On this basis, it is suggested that a company can charge depreciation at
rates which are lower or higher than those specified in Schedule XIV.
It may be clarified that the rates as contained in
Schedule XIV should be viewed as the minimum rates, and, therefore, a company
shall not be permitted to charge depreciation at rates lower than those
specified in the Schedule in relation to assets purchased after the date of
applicability of the Schedule. However,
if on the basis of a bona fide technological evaluation, higher rates of depreciation are justified, they may be
provided with proper disclosure by way of a note forming part of annual
account.
4)
Can SLM rates be different than those specified under Schedule XIV
It is stated that SLM rates (corresponding to the
Written Down Value (WDV) rates, as per Schedule XIV) can be different than
those prescribed under Schedule XIV provided a company continues to determine
the rates as provided under section 205.
Thus, against SLM rates prescribed under Schedule XIV of 11.31 per cent
(triple shift rate for general plant and machinery), a company can charge
depreciation at the rate of 10.56 per cent.
It may be mentioned that the rate of 11.31 per cent,
has been determined on the basis of eight years and six months or so of
specified period whereas if 95 per cent is divided by nine years, the
corresponding SLM rate comes to 10.56 per cent. The argument is that for calculating the SLM rates, complete
years have to be taken into account whereas the rates under Schedule XIV also
take into account fractions of years.
It is clarified that a company must necessarily
provide SLM depreciation at the rates prescribed under Schedule XIV and the
interpretation that fractions of years cannot be taken into account is not
correct.
* CIRCULAR NO.2, DATED 7.3.1989.
What procedure
is required to be adopted by companies for charging depreciation on
straight-line method on assets purchased earlier to the change in rate of
depreciation during 1983.
1. During the year 1983, the rates of depreciation
under the Income-tax, have been changed on some of the assets. As the depreciation provision in the annual
accounts of the companies under section 205/350 is related to the rates of
depreciation as provided in the Income-tax, any change in the rates under the
Income-tax Act affects the provision of depreciation in the annual accounts of
the companies. As a result, this
Department has received several queries/representations from companies
enquiring as to what procedure they should adopt for charging depreciation on
straight-line method on the assets purchased earlier to the change in the rate
of depreciation as provided in the Income-tax Act.
2. This issue has been examined in this Department and it
has been decided that under sub-section (5) of section 205, specified period
for providing depreciation on straight-line method under clause (b) of
sub-section (2) of section 205 has to be recalculated on the basis of the
revised rates under the Income-tax Act.
The companies which adopt the straight-line method of depreciation
should provide for the depreciation in their annual accounts on the following
basis:
1.
Number of years for which asset has already been depreciated, Say
'A' years
before
the change in depreciation rates
2.
Specified period calculated at revised rates by which 95 per Say
'B' years
cent
of the original cost of asset would have depreciated on
written
down value method at revised rates.
3.
Written down value of the asset in the books at the beginning Say
Rs. 'X'
of
the year in which rates have been changed under the Income-
tax
Act
4.
5 per cent of the original cost Say
Rs. 'Y'
5.
Fixed instalments of depreciation to be provided each year
after
the rate has been changed shall be calculated as per the X—Y
formula:
If 'A' is greater than 'B', then the amount (X—Y)
may be provided B—A
for
as depreciation in the year in which rates are changed
*
CIRCULAR NO. 1/85, DATED 10.1.1985
Transfer to
reserve of certain percentage of profits-Queries arising from the Companies
((Transfer of Profits to Reserves) Rules, 1975 and the Companies (Declaration
of Dividend out of Reserves) Rules, 1975 answered
The Department has received a number of queries in
respect of the above mentioned rules.
The points raised have been duly considered and the Department's views
thereon are indicated below:--
Query 1 : Whether arrears of depreciation mentioned in
sub-section (1) of section 205 should also be provided before arriving at the
profits for the purpose of transfer of specified percentage thereof to reserve
in terms of rule 2 of the Transfer of Profits to Reserves Rules?
Answer
: Yes, arrears of depreciation mentioned in sub-section (1) should also be
provided.
Query
2 : Whether the term "current profits" used in rule 2 refers to
profits after tax or before tax?
Answer
: It refers to profits after tax.
Query 3: Whether the profits transferred to
development rebate reserve should be excluded in working out current profits for ascertaining the
amount to be transferred to reserves under the rules?
Answer : The current profits mean profits after
statutory transfer to the development rebate reserve.
Query 4 : Whether reference to dividend made in the
rules is to both equity and preference dividend or to equity dividend along?
Answer : The reference is to equity dividend and
also to that portion of dividend relating to participating preference shares
over and above the fixed rate of preference dividend.
Query 5 : Whether transfer to development rebate
reserve, capital reserve or special
reserve will meet the requirement of transfer to reserves under the rules?
Answer
: The reply is in the negative.
Query
6 : Whether in case the proposed dividend is less than 10 per cent, is it
necessary to transfer any amount to reserves under the rules?
Answer
: No amount is required to be transferred to reserves in such cases.
Query 7 :
Whether a company can transfer to reserves a higher percentage of its
dividend than that applicable to the proposed dividend slab such transfer being
of less than 10 per cent of its current profits?
Answer : The reply is in the affirmative.
Query 8 : Whether for the purposes of rule 3(i) it
is necessary to declare a dividend?
Answer : Yes.
It is necessary to declare dividend.
Query 9 : Whether these Rules make the provisions of
section 5A of the Companies (Temporary Restrictions on Dividend) Act, 1974
mandatory in certain cases?
Answer : Since there is no inconsistency with the
provisions of the Companies (Temporary Restrictions on Dividend) Act, the
provisions of these Rules will have to be complied with.
Query 10 : Whether after transfer of 10 per cent of the current profits to reserve,
the remaining undistributed profits could be carried forward in the profit and
loss account?
Answer : The Rules do not prohibit a company from
carrying forward any balance of current profit and loss account without
transferring them to reserves.
Query 11 : Whether for working out of the average rate of
dividends for the purpose of rule 2(1) , no dividend years should be excluded?
Answer
: The reply is in the negative.
*
CIRCULAR NO.8/76 [1/1/76-CL-V], DATED 18.5.1976, READ WITH 12/76
[1/1/76-CL-VI], DATED 10.6.1976.
Clarification
2
Enquiries have been made in regard to the clarification of
term "reserves" mentioned in the Transfer of Profits to Reserves
Rules framed in pursuance of section 205[2A].
The matter has been examined and the Department is of the view that the
term "reserves" referred to in the said rules means only "free
reserves".
*
CIRCULAR NO.21/76[8/30/(205A)/75-CL-V], DATED 19.7.1976
Clarification
3
Query : Section 205(2A) provides that
"Notwithstanding anything contained in sub-section (1), on and from the
commencement of the Companies (Amendment) Act, 1974, no dividend shall be
declared or paid by a company for any financial year 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), except after the transfer to the
reserves of the company of such percentage of its profits for that year, not
exceeding 10 per cent, as may be prescribed: Provided that nothing in this
sub-section shall be deemed to prohibit the voluntary transfer by a company of
a higher percentage of its profits to the reserves in accordance with such
rules as may be made by the Central Government in this behalf."
The word "higher" in this connection could
only have been a mistake because no legislation should or could possibly
prohibit or regulate a higher "percentage" of profits to be
transferred to reserve. Such a transfer
of a higher amount would be in accordance with a sound financial policy. The intention of the proviso could only be
that a "lower" percentage may be transferred to reserve funds in
accordance with rules to be made by the Central Government to provide for cases
of hardship. following this
"error" in the proviso, now the Government has come out with a new
set of Rules under which a company is prohibited from transferring more than a
certain percentage of its profits to the reserves. The result would be that in many cases the companies would be
forced to carry forward large amounts as balance to the credit of profit and
loss account but not as "reserves".
If the management of a company wishes to transfer a certain amount to a
reserve, there is no conceivable good reason to place a restriction on such
transfer. The situation seems to be
that because of a drafting error in the proviso, Rules have now been framed to
comply with the erroneous proviso. It
is, therefore, requested that the proviso should be amended to substitute the
word "higher" by the word "lower" and the rules prescribing
conditions governing voluntary transfer of "higher" percentage (i.e.,
higher than 10 per cent of the profits) to the "reserve" should be
repealed.
Answer : The matter has been examined. The contention of the chamber that the word
"higher" used in proviso to section 205(2A) was a mistake is not
correct. It is only an enabling
provision to transfer voluntarily a higher percentage of profits to the reserves
subject of course to the rules made by Government in this behalf.
*
LETTER NO.8/3/76-CL-V, DATED 12.3.1976.
Clarification
4
Query : Whether transfer to general reserve can be made
through profit and loss appropriation account from current year's profit which
carried forward considerable amount of profit from previous year? In such case it is difficult to ascertain
whether the transfer is from current year's profit or from earlier year's
profit.
Answer : The amount to be transferred to the general
reserves would be worked out in respect of the profits of the year in question
and without bringing in the profits of the past years.
*
LETTER NO.8/2(MISC.0/75-CL-V, DATED
6.6.1975.
Clarification
5
Query : Rule 2 prescribes that amounts should be
transferred to reserves depending on the amount of dividends to be
declared. The amount to be transferred
is expressed as a percentage of current profits. Neither the Act nor the Rules define "current
profit". Having regard to the word
"current" used, it would appear that past losses are not to be
deducted as required for the computation of net profits under section 349. Further, there is a controversy whether the
profit should be the amount before tax or the amount after tax. Having regard to the words "profits
after tax" used in rule 3 in contradistinction to the words "current
profits" used in rule 2 and the ordinary
meaning of the words
"current profits"' it would appear that the profits before tax have
to be considered as current profits. It
is not clear whether items like development rebate reserve written back or
adjustments relating to previous years can be taken into account while arriving
at current profits.
Answer : Sub-section (2A) of section 205 provides
for the declaration or payment by a company of a dividend only after providing
for depreciation and after the transfer to the reserves of a percentage of its
profits. the profits available for
distribution as dividends can only be the profits after tax and not before
tax. the expression "current
profits" used in rules 2 and 3 of the Transfer of Profits to Reserves
Rules accordingly refers to profits after tax.
Further, items like "development rebate reserve" written back,
or adjustments relating to previous years will also have to be taken into
account before arriving at the "current profit" for the purpose of
the said Rules.
*
LETTER NO.6/13/75-CL-XIV, DATED 7.2.1976.
Clarification
6
A question has been raised as to how rule 3 of the
Transfer of Profits to Reserves Rules (as amended by the Amendment Rules, 1976)
would be applied in the case of a newly incorporated company in which case no
dividends would have been declared over the three years immediately preceding
the financial year. The Department is
of the view that in such a case rule 3 would not be applicable. Such a company would, therefore, be governed by the provisions contained in rule
2. In other words, the company is
prohibited from transferring more than 10 per cent of its profits to its
reserves.
*
CIRCULAR NO.20/76/[5/10/76-CL-XIV AND
1/1/76-CL-V], DATED 26.7.1976.
Clarification
7
Query : On a plain reading of rule 2, it appears that no
obligation is cast on companies to transfer any amount from its current profits
to reserves if the dividend proposed is 10 per cent or less of the paid-up
capital. Please confirm Rule 3 goes
much beyond the substantive part of the parent Act, i.e., section 205(2A) and,
as such, no conditions should be laid down in case of those companies desiring
to transfer more than 10 per cent of their current profits to reserves. Quite apart from this, the clause penalises
prudent management. If because of
future expansion or diversification or because of expectation of a lower profit
in future, a company desires to distribute dividend at a rate lower than the
average rate of dividend declared for the immediately preceding three years,
which prudent management may wish to do, then the company would be committing a
breach of the rules. It would also be
difficult for companies to maintain the rate of dividend calculated at the
average rate of dividend declared by
the company for the three years immediately preceding the current year, where
the capital base has been increased on account of issue of bonus/right shares.
Answer : In regard to the Transfer of Profits to Reserves
rules, the presumption made in (a) above is confirmed. As for item (b) goes, contention that clause
3 of the Rules goes much beyond the substantive part of the section, namely,
section 205(2A) is not correct. The
object of the legislation is to effect a harmonious blending between the
interests of capital formation and to ensure equitable return to the
shareholders. While there is no
requirement of transferring any amount to reserves if the dividend is declared
up to 10 per cent for declaring dividend over this percentage and not exceeding
20 per cent there is a requirement to compulsorily transfer a prescribed
percentage to the reserves as laid down in rule 2. In cases where the company wishes to transfer more than 10 per cent
of profits to reserves in a year, it can do so after complying with the
provisions of rule 3 which has now been reworded under the Amendment Rules,
1976.
*
LETTER NO.6/15/75-CL-XIV, DATED 3.8.1976.
Whether "specified
period" is to be determined with reference to original cost and yearly
quantum of depreciation
Query : It is not clear how the "specified
period" as referred to in sub-section (5) is to be worked out in existing
companies where a portion of depreciation has already been written off. It may be considered whether as a matter of
practical convenience, the balance of the written down cost could be divided by
the number of years (specified period)
as provided in sub-section (5)(a) for computing annual depreciation to
be provided hereafter or otherwise how
computation of net depreciation is contemplated, keeping into consideration the
amount of depreciation already written off and the residual term of the
specified period.
Answer : The
specified period will have to be determined with reference to the original cost
and the yearly quantum of depreciation.
Under the straight-line method depreciation will have to be determined
accordingly. However, reference to original
cost is for the above limited purpose of determination of the specified period
and quantum and once the instalment has been determined it will be deducted
from the written down value and not from "original cost". It would, therefore, not be necessary to
provide again the depreciation already provided in the books in respect of a
particular asset in any financial year ending prior to 28th December, 1960.
*
CIRCULAR NO.CLAS/24, DATED 27.6.1961 ISSUED BY INDIAN CHAMBER OF COMMERCE,
CALCUTTA.