3.3       Query

Application of Section 205 A (3) in case Investment Allowance Reserve

released after the statutory period is credited to profit and loss account.

1.The querist has drawn the attention of the Expert Advisory Committee that divisible profits of a company include amounts written back to the profit and loss account on account of Investment Allowance Reserve and Development Rebate Reserve on the expiry of the statutorily prohibited period stipulated under Sections 32 A (5) (c) and 34 (3) of the Income-tax Act, respectively.

2.The querist has mentioned the case of a company where for the purpose of the proposed dividends, the divisible profits arrived at as above are adequate. However, if the adjustments by way of write-back of Investment Allowance Reserve and Development Rebate Reserve are excluded, then, the balance amount of divisible profits falls short of the proposed dividends.

3.In this context, the querist has sought the opinion of the Committee as to whether the company is bound to adhere to the provisions of Section 205A (3) of the Companies Act, 1956 read with rules made thereunder.

4. In this connection, the querist has drawn the attention of the Committee to its opinion reported in Compendium of Opinions, Volume VI, at page 87. The Committee has opined in that case that write-back of Investment Allowance Reserve to the profit and loss account is available for the purpose of distribution by way of dividends provided Section 205A (3) of the Companies Act, is complied with.

5.The Committee’s attention is, however, invited by the querist to the opinion expressed by the Company Law Board as per its letter No. 6/13/75-CL-XIV, dated 7.2.1976, reported in “Circulars and Clarifications of Company Law” by Bhargava & Bhargava, 1985 Edition, at page 148. The Department has expressed the view that in the context of Section 205 (2A) of the Companies Act, 1956, the expression “current profits” would include items like Development Rebate Reserve written-back. In view of this clarification, the querist has sought the opinion of the Committee as to whether it is possible to contend that if the divisible profits are comprised of write-backs on account of Investment Allowance Reserve and Development Rebate Reserve, totality of such divisible profits is the profit of the year not involving payment of dividend out of accumulated profits earned by the company in previous years and transferred to Reserves in terms of Section 205A (3) of the Companies Act, 1956.

6.In conclusion, query raised by the querist for the Committee’s opinion is that in the above facts and circumstances whether the company could contend that it is free to distribute whatever amounts of dividends without being constrained to follow the provisions of Section 205A (3) of the Companies Act, particularly when the amount of accumulated profits was transferred by the company to the Investment Allowance Reserve and Development Rebate Reserve in the previous years under a statutory compulsion for use for specified purpose as distinguished from the General Reserves appropriation which is a voluntary act of the company where there is no statutory compulsion to use such reserve in a particular manner.

                                                                          Opinion                                  November 6, 1987

1.The Committee notes that “Explanation” contained in the “Companies (Declaration of Dividend out of Reserves) Rules, 1975” made pursuant to Section 205A (3) of the Companies Act, 1975, explains as below:

“For the purpose of this rule, ‘profits earned by a company in previous years and transferred by it to the reserves’ shall mean the total amount of net profits after tax, transferred to the reserves as at the beginning of the year for which the dividend is to be declared; and in computing the said amount, the appropriations out of the amount transferred from the Development Rebate Reserve [at the expiry of the period specified under the Income-tax Act, 1961 (43 of 1961)] shall be included and all items of Capital Reserves including reserves created by revaluation of assets shall be excluded.”

2. The Committee notes that the earlier opinion of the Expert Advisory Committee, referred to by the querist in para 4 of the query, was in respect of the Investment Allowance Reserve created in a year in which it was not statutorily required and thereafter used for the purpose of declaration of dividends in a subsequent year, whereas, the present query relates to the investment allowance reserve released on expiry of the statutory period stipulated in the Act. Thus, the facts and circumstances of the two queries are different.

3.On the basis of the above, the Committee is of the opinion that the “profits earned by a company in previous years and transferred by it to reserve” means the aggregate of net profit after tax and actually transferred to reserve. Thus, in case the company write-backs to the profit and loss account Investment Allowance Reserve and Development Rebate Reserve on the expiry of the statutorily prohibited period under Sections 32 A (5) (c) and 34 (3) respectively, of the Income-tax Act, 1961, then sub-section (3) of Section 205 A will have no application. In view of this, the Committee is of the opinion that in that situation, the company will be free to distribute the amount as dividend without any restriction imposed by the Companies (Declaration of Dividend out of Reserves) Rules, 1975.

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