Calculation of divisible profits

1.A limited company engaged in steel and paper manufacturing closes its accounts on 30^th September every year.

2. During the year 1983-84, it installed a paper manufacturing plant. The company follows straight line method of depreciation. During the year 1983-84 it had net profit of Rs. 17 lacs after making full provision for current year depreciation for Rs. 101 lacs. During that year, though the company did not have taxable income, still on the basis of an advice form its taxation advisors, the company created an Investment Allowance Reserve for Rs. 125 lacs for the year 1983-84 and Rs. 17 lacs for earlier years. After adjustment of Rs. 15 lacs brought forward balance of profit and loss account it had finally a debit balance of Rs. 110 lacs, which was shown in the balance sheet.

3. During the current year (1984-85) the company has about Rs 100 lacs net profit after making full provision for current year (1984-85) depreciation on SLM method at Rs. 103 lacs, leaving a net debit of Rs. 7 lacs in the balance sheet. Also there are arrears of depreciation for earlier years at Rs. 28 lacs.

4.The directors are desirous to declare dividend out of current year’s profit, without making good the brought forward loss of Rs. 110 lacs, on the plea that they have created Investment Allowance Reserves for Rs. 142 lacs during 1983-84 and 1984-85.

5. In the view of the querists, the company having provided the Investment Allowance Reserve during 1983-84, as a consequence of which there arose a debit balance in profit and loss account, it can not make the payment of dividend out of the current year’s profit without fully making good the debit balance of profit and loss account and without making good the arrears of depreciation for earlier years, even though the company might not be required to create the Investment Allowance Reserve either during 1983-84 or 1984-85 as there being no taxable income. Further, the company is also not willing to write back the Investment Allowance Reserve created during 1983-84 as it fears that it may not get the benefit of the same in Income-tax.

6. The company however argues that, in the absence of the taxable income, it was not required to create the Investment Allowance Reserve and had it created the Investment Allowance Reserve during 1983-84, there would have been no debit balance in the profit and loss account and it would have also provided for the arrears of depreciation and there would have been a large credit balance in the profit and loss account and it would have been able to declare the dividend without any doubt. By simply keeping the profit in Investment Allowance Reserve Account, it must not be disqualified to declare the dividend.

7. The querists have sought the opinion of the Expert Advisory Committee as to whether the company can declare dividend in the year 1984-85 in the above circumstances.

Opinion May 21,1986

The Committee is of the opinion that the Investment Allowance Reserve, created in a year in which it was not statutorily required, can be used for the purpose of declaration of dividend in a subsequent year, provided it is credited to the profit and loss account of that year and the relevant provisions of Companies (Declaration of Dividends out of Reserves) Rules, 1975, and Section 205 (A) (3) of the Companies Act, are fulfilled.

_____________________________