Dividends

In one line

A dividend is a distribution of profit, and the Act's whole concern is that it should be paid out of profit and not out of capital, so it fixes the funds a dividend may come from, the order in which losses must be set off first, the deposit of the money within five days, and a punishment for declaring a dividend and then not paying it.

In exam wording: under section 123(1) no dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year arrived at after providing for depreciation, or out of the undistributed profits of previous financial years similarly arrived at, or out of both, or out of money provided by the Central or a State Government for the payment of dividend in pursuance of a guarantee given by that Government.

Why the law has this at all

A company's capital is the creditors' security. The members contributed it on terms that it stays in the company, and the creditors gave credit on the footing that it is there. A dividend paid out of capital is therefore a return of the creditors' security to the members, which is why the common law developed the rule that dividends come only out of profits and why the Act now states that rule in statutory form.

Everything in s.123 follows from that single proposition.

The funds are closed. Sub-section (1) is exhaustive: current profits, past undistributed profits, both, or Government money under a guarantee. Nothing else.

Profit must be real. Depreciation must be provided first, sub-section (2) and Schedule II. Unrealised gains, notional gains and revaluation surpluses are excluded by the proviso inserted in 2018. Carried-over losses and unprovided depreciation must be set off by the proviso inserted in 2015. Each of these closes a route by which a paper profit could be turned into a cash payment.

Reserves are fenced. No dividend from reserves other than free reserves, and s.2(43) defines free reserves so as to exclude the same unrealised and fair-value amounts.

The money must leave the company's hands. Sub-section (4) requires the dividend to be deposited in a separate account in a scheduled bank within five days of declaration, so that a declared dividend cannot quietly remain working capital.

And it must actually be paid. Section 127 makes failure to pay within thirty days an offence, and s.124 sweeps unpaid amounts into a separate account, treated in [Unpaid Dividend and the IEPF].

What a dividend is

Section 2(35) provides only that "dividend" includes any interim dividend. The Act does not otherwise define it, so the meaning is the general one: a distribution to members out of divisible profits, in proportion to their holdings.