Clearly, the Ministry of Corporate Affairs (MCA) is working fast and hard, in correcting the scores of anomalies and absurdities of the law passed and hurriedly enforced by the previous government. Over the last few days, lots of circulars, notifications and removal ofdifficult orders have continued to flow in. However, the abominable tendency to push through substantive changes in the law, while ignoring the parliamentary process continues unabated. The change discussed in this article, made by a notification of 12th June, actually amounts to putting in place a completely new provision for offsetting of past losses before companies may distribute dividends. This changes the position as it prevailed under the 1956 Act, and this change was nowhere discussed by any of the Committees that preceded the 2013 Act. Neither does the main law, the 2013 Companies Act envisage such a change. Therefore, the question is – could such a substantial change in law have been done by a virtually unnoticed notification?
Dividend declaration rule:
Rule 3 (5) of the Declaration and Payment of Dividend Rules has been replaced by a notification of 12th June 2014. The rule, before its replacement, read as follows:
(5) "No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year are set off against profit of the company of the current year the loss or depreciation, whichever is less, in previous years is set off against the profit of the company for the year for which dividend is declared or paid."
Clearly there was something terribly wrong with the language of the old Rule. Now, the said garbled rule has been replaced by the following:
(5) "No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against profit of the company of the current year."
Impact of the change:
The amendment, besides clearing the wording of the earlier rule, marks a change from the position in the 1956 Act. In sec 205 (1), proviso (b) provided as follows:
(b) if the company has incurred any loss in any previous financial year or years, which falls or fall after the commencement of the Companies (Amendment) Act, 1960, then, the amount of the loss or an amount which is equal to the amount provided for depreciation for that year or those years whichever is less, shall be set off against the profits of the company for the year for which dividend is proposed to be declared or paid or against the profits of the company for any previous financial year or years, arrived at in both cases after providing for depreciation in accordance with the provisions of sub-section (2) or against both;
Though the language of the proviso was also unclear, but in Ramaiya's Guide to Company Law, this proviso has been discussed at length. The interpretation has been that if there is a loss before depreciation, and then there is a loss after depreciation, it is necessary to offset only the depreciation and not the loss before depreciation. This interpretation became clear with the combined reading of proviso (a) below sec 205 (1) with proviso (b). Proviso (a) required the company to provide for depreciation, if the same was not provided for in the previous years. There was nothing in sec 205 (1) requiring the company to offset losses of previous years before declaring dividends.
Now, Rule 3 (5) requires all "carried over losses" and all unprovided depreciation to be offset before declaring any dividends.
For companies that have just turned around, attracting capital on the strength of dividend payments becomes quite important, particularly if it is preference capital. If the company has to make good all its past losses before it starts distributing dividends, the company's ability to declare dividends, particularly when it is so necessary to attract capital infusion, gets impaired.
Substantive change comes silently via a subordinate law:
The tendency of pushing through substantive changes in the law through 'Rules',completely bypassing the parliamentary process, continues unabated and is an extremely undesirable practice. Before a law changes substantively, there are extensive pre-Parliament discussions (such as the Irani Committee, Standing Committee of Parliament, etc). There may be debates in the House as well. There is a benefit of a Bill, discussions with the stakeholders, and so on. However, the change in the Rules simply comes by way of a notification, and it may actually change the law substantively.
The present change in the dividend distribution rights of companies is an example. Section 123 (1) (a) provides for payment of dividends out of current profits. It does not make any reference to offsetting of losses of previous years. Neither does it empower the Central Government to make any rules about what amounts may be offset before distributing dividends. It is questionable as to how the Central Government goes and make a rule with no empowering provision in the Act.
There is no discussion in the Irani Committee Report, or in the Parliamentary Committee reports, on the issue of whether past losses should be offset before distributing dividends.
(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance. He has written a book titled "Securitisation, Asset Reconstruction and Enforcement of Security Interests", published by Butterworths Lexis-Nexis Wadhwa.)
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