The term “divisible profits” means all profits which can legally be distributed among the shareholders of a company as dividend. However, neither the Companies Act nor the legal decisions explain clearly what is meant by divisible profits. Among the various legal decisions in regard to divisible profits, two are of crucial importance. In one case (Buenos Aires Great Southern Railway Co. Ltd. v. Preston, 1947), the court held that “Profits of the Company” means profits available for declaration as dividends after setting aside to reserve such amounts as the directors deem necessary. In another case (Fisher v. Black and White Publishing Company. 1901), the court stated that “profits available for dividend” means “net profits after making any deductions which the directors can duly make.”
The Companies Act does not define what is meant by divisible profits. Section 205 of the Act lays down that:
(a) Dividends may be declared out of the profits of the company for the current year after (1) providing for depreciation for the current financial year as well as for all past arrears of depreciation, and (ii) transferring a prescribed percentage of its profits (not exceeding 10 per cent) to reserves.
(b) Dividends may be declared out of the undistributed profits of any previous financial year or years in accordance with the rules framed by the Central Government in this behalf.
(c) A company can also declare dividends out of the moneys provided by the Central Government or State Government for payment of such dividend in pursuance of a guarantee given by that Government.
The Central Government may however allow any company to declare or pay dividend for any financial year without providing for depreciation if it deem necessary in the interest of the company. Further, if a company has incurred any loss in any previous financial year or years, the past losses must be analysed into losses before depreciation and the losses arising on account of depreciation. To the extent to which the loss consists of loss arising otherwise than on account of depreciation, it is not required to be deducted.
Thus “divisible profits” are those profits which are arrived at after deducting all the expenses including the taxes payable to the state by the company. It follows that dividends can be paid only out of profits. In the absence of any government guarantee, a company can never pay dividends except out of its own profits. “Dividend is a return on capital and not a return of capital”. The amount that can legally be distributed as devidend is determined by the management in a accordance with (a) the provisions of the Companies Act, (b) the company’s Articles of Association which, however must not be ultra vires the Company Act, (c) Regulations 85 to 94 of Table A of Schedule 1 appended to the Companies Act in case the company has no Articles of its own, (d) judicial decisions in leading cases, and (e) the contractual and other legal factors in certain circumstances.