Dividend rules tweaked: MCA makes setting-off of past losses mandatory

The tendency of pushing through substantive changes in the law through the Rules, completely bypassing the parliamentary process, continues unabated and is an extremely undesirable practice adopted by the MCA

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 of difficult 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Rule 3 (5) of the Declaration and Payment of Dividend Rules has been replaced by a notification of 12th June 2014.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 Now, the said garbled rule has been replaced by the following: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.)




3 years ago

Sir Nice Articles.

Nagesh Kini

3 years ago

Vinod - Thanks for your write up that is most apt.
Indian Hotels Co. Ltd. the owners of the iconic Taj group in 2012-13 despite having substantial losses for the year declared dividends claiming that they are out of retained earnings. It begs the question - is it good corporate governance to deplete the bank balances when the company is in bad shape just to 'keep shareholders happy'?

Nagesh Kini

3 years ago

Vinod - Thanks for your write up that is most apt.
Indian Hotels Co. Ltd. the owners of the iconic Taj group in 2012-13 despite having substantial losses for the year declared dividends claiming that they are out of retained earnings. It begs the question - is it good corporate governance to deplete the bank balances when the company is in bad shape just to 'keep shareholders happy'?

Why should government fund PSU banks all the time?

At least some of the PSU banks cannot claim to be cash-strapped, especially looking at their cash reserves. By capitalising their reserves instead of seeking fund from the government, they would be rewarding their share holders as well

Press reports indicate that some of the public sector banks (PSBs) are seeking more capital ahead of the budget, which is scheduled to be presented by the second week of July. According to these reports, cash-strapped public sector banks "hit by a higher proportion of stressed assets and global Basel III requirements" have begun listing out capital requirements ahead of the budget in July.


In the interim budget, the Congress-led United Progressive Alliance (UPA) government had earmarked Rs11,200 crore as capital for all public sector banks. In 2012-13, the government had, in fact put in Rs14,000 crore. This kind of funding must stop, and the banks need to be able to generate their required funds from investing public.


Since the last couple of months, all leading newspapers have carried details of the balance sheet of a large number of organisations, including pubic sector banks. The following information has been collected from these announcements:


Name of Bank

Paid up Capital (Rs crore)

Reserves (Rs crore)

Allahabad Bank



Bank of Baroda



Bank of India



Bank of Maharashtra



Canara Bank



Corporation Bank






Karnataka Bank



State Bank of India



Syndicate Bank



UCO Bank



Union Bank




From the above, most of the banks mentioned appear to have healthy cash reserves. If and when they need funds, they should be able to raise it from the investing public either by rights issue or even by capitalising their reserves.


However, in the present situation, specific amounts of assistance appears to have been sought from the government by IDBI and Indian Overseas Bank, and it is likely that some more may join the band wagon to seek capital infusion.


As mentioned above, at least some of the banks cannot claim to be cash-strapped! By capitalising their reserves, they would be rewarding the share holders too.


In the meantime, it is being reported in the press that GS Sandhu, secretary for financial services, has underlined the need for banks to sell off their non-core assets. The companies identified as non-core include rating agencies such as ICRA, CARE, National Stock Exchange (NSE), IL&FS, UTI, Multi-Commodity Exchange (MCX), Stock Holding Corp of India Ltd (SCHIL), Central Depository Services (India) Ltd (CDSL), and asset reconstruction corporations (ARCs). The estimated value of these assets would be around Rs25,000 crore.


As we can see from the details given above, the reserves are huge, compared with the paid up capital of these state-rund lenders. It is pay back time for these banks. Why not buy out the government share in line with the established formula for this purpose and reduce the government holdings?


Years ago, the Atal Bihari Vajpayee government had suggested that the Centre could reduce its stake in public sector banks to 33% but the move did not go through as the law could not be amended. Now this can easily be achieved and Vajpayee's proposal could be implemented!


After doing this, should the banks need any additional capital infusion, they ought to go to the shareholders instead of going back and forth to cash rich Life Insurance Corp of India (LIC) and other similar institutions, which only means that the Government stake would keep rising, instead of being held by the investing public.

(AK Ramdas has worked with the Engineering Export Promotion Council of the ministry of commerce. He was also associated with various committees of the Council. His international career took him to places like Beirut, Kuwait and Dubai at a time when these were small trading outposts; and later to the US.)




Ralph Rau

3 years ago

This article seems based too be based on the assumption that Reserves = Free Cash

In reality the Reserves = Liability side of the balance sheet is not free cash. It is sitting blocked as a Loan to the bank's borrower. And a lot of these loans are sticky and being rolled over given the borrowers inability to re-pay ?

sabyasachi samal

3 years ago

I find many who comment here on banks i find the writer or the opinion providers are ignorant of or not experienced in having banking related works...even they claim to be what so...I humbly request to all writers please understand why the situation is like this....Why only for government banks? If government banks will not fund the undeserved persons and did not fund the farmers who are the worst people in our country from banking point of view then these banks would not been in such a situation again if these banks do not fund mallya this could also be avoided...I find one thing behave like rural money lender if you do not able to pay i will throw you from your house and will auction your house...If this type of practices are being followed then no fund is needed from stupid government...I think all CA and Finance experts will be able to understand so...Please come to a village and live the life of a banker only writing in AC room will not yield anything.

Dr Anantha K Ramdas

3 years ago

Thank you Mr Gopalakrishnan for your comments. There are quite a few PS Banks that are not asking for "infusion" of capital because they have learnt the art of banking and are self-reliant.

For once let the Government refuse and say that "you guys fend and fund yourself;if not we will sell our shares to public and the work be done on a professional basis" Such a stern warning would make them wake from their deep slumber and start working to get results.

No more spoon feeding please at the cost of tax payer.


suman chakraborty

In Reply to Dr Anantha K Ramdas 3 years ago

Blaming PSU bank management for the bad financials of PSU, is the typical blame it on somebody else mentality.
PSU banks and LIC has been subjected to financial raping by Central Govt. Mandatory loans to undeserved entities, whimsical loan waivers etc. adds to the NPA as well as overall de-motivation of Staff.
The problems are very deep rooted and no superficial solution will work.

Gopalakrishnan T V

3 years ago

The only reason that can be adduced for PSU banks' dependence on tax payers' money is total Governance deficit. The Board is neither accountable nor respomsible and the members of the Board have no sense of involvement and commitment. When the balance sheets are strong,the reserves are very high,NPas are reasonably low and Capital adequacy ratio is well above the prescribed regulatory requirement, the Government should not extend any capital support. Further,if the dividend received by the Government far exceeds the normal return on equity investment,then also further capital induction is unnecessary. Is there any analysis done by the Board or by the Government or RBI before capital is inducted? It is time tax payers and depositors have some say in the management of the Bank. There should be representatives of tax payers and depositors on banks board or at least they should have some say when the NPAs reach beyond certain levels, expenditures exceed certain cut off limits, fall in dividend distribution and there is induction of capital by the Government.Time a close watch is kept on banks' functiong by depositors body.

Copper, iron ore hoarding by 'creative' Chinese borrowers

Clothes-makers, food manufacturers, and other businesses who were never involved in the copper or iron ore trade were buying large amounts in China. They did not want it to make anything. They needed it to raise cash

Businessmen and women often are extremely clever in developing various arbitrage schemes. These schemes become especially prevalent during periods of easy credit when lenders are less sensitive about risk. One such scheme has recently had some adverse publicity, commodities financing in China.


Often, the creativity of borrowers is inspired by regulations. This was true in China in 2010. China is the world’s second largest economy and accounts for about 40% of the global demand for copper. Copper is relatively valuable, simple to store, transportable and does not deteriorate. As such it is perfect to use as collateral. In 2010, the Chinese government was involved in one of their periodic curbs on credit excesses. This put a lot of businesses in a quandary. Clothes-makers, food manufacturers, and other businesses who were never involved in the copper trade were buying large amounts. They did not want it to make anything. They needed it to raise cash.


The process went like this. They used funds as collateral to get a letter of credit (L/C) from their bank. They used the proceeds of the L/C to buy copper. The copper could then be sold or used as collateral for more loans. The owners could use the proceeds for operations or more often they would make loans at higher interest rates to someone who needed the money more. The L/C did not have to repaid for 90 days at a cost of 30 basis points or 180 days for 70 basis points. In that period, traders could invest in the shadow banking products and earn a return of over 10%.


The business community liked the trade because it provided credit and could make quite a bit of extra money. The banks liked to issue the L/Cs because the transaction was off the balance sheet. They could use the collateral put up for the L/C to make more loans and the bank clerks who issued the L/C received a commission.


Again the regulations changed. The People’s Bank of China (PBOC) tried to reign in this scheme. They required the banks to put the original collateral held against the L/C into a low yielding reserve account. While this did not prohibit the transaction, it did make it less profitable for the banks. So the traders adapted. They went off shore.


This had several advantages. Thanks to the US Federal Reserve, dollar loans were cheap. They could use the proceeds of the L/C to make yuan loans at higher rates. So the arbitrage with copper went on.


Not only did traders use copper to provide financing, the scheme spread to imported iron ore. Iron is not really ideally suited for this type of trade, but China has a large over capacity in steel making and the demand is slowing. The mills need the money. So they turned to commodities financing. They did this until the China Banking Regulatory Commission (CBRC) put pressure on the banks to increase lending requirements. Iron ore futures contracts dropped 5%, the largest drop since the contracts were introduced in October 2013.


Borrowing off shore in Singapore and Hong Kong adds another layer to the risk. The scheme has enough of that already. There is commodity risk. The value of the copper could go down during the period of the L/C. There is interest rate risk. As the iron example shows there is substantial regulatory risk in China. When the transaction is offshore there is foreign exchange risk too. While the yuan was appreciating this did not seem like a problem, but its recent fall brought the risk into focus. Perhaps the most dangerous is information risk. The trade distorts information about the copper market. It distorts the export numbers and distorts the loan numbers.


These risks would have been dangerous enough, but the most recent risk put the others in perspective: fraud. To get financing the owner of the copper had to have a receipt from a bonded warehouse, a piece of paper. Sometimes this receipt was issued ten times, allowing the trader to secure ten loans for the same collateral.


Of course, all good things must come to an end. Recently one of China’s largest enterprises, the state owned financial firm, CITIC, became suspicious and asked a court in the port city of Qingdao to give it access to the collateral held in warehouses. The possibility of fraud not only in Qingdao but also in the port of Penglai sent chills down the spines of loan officers not only in China, but also several foreign banks including Citigroup Inc., Standard Chartered PLC, Standard Bank PLC, ABN Amro Bank NV, BNP Paribas SA and Natixis. It also impacted the price of copper, which dropped 4.5% on the London Metals Exchange.


Some commentators have dismissed this issue as a one off small risk. After all only 2% of refined copper arrives in Qingdao. Most of it arrives in Shanghai where standards are theoretically higher. If this one case of fraud were all that there was to worry about, they would be correct, but it isn’t.


The issue is much greater because it represents several major issues regarding the Chinese financial system. First are the lengths that businesses will go to, for access to credit at almost any price. Second is the ease of avoiding an uneven regulatory system. Finally it illustrates issues with information in China.


Commodities financing is not just about copper and iron. It also takes place for gold, aluminum and even foods like soybeans and palm oil. According to Goldman Sachs commodity financing could account for as much as $160 billion, or about 30%, of China’s short-term foreign-exchange borrowing.


Commodities financing like other debt schemes in China is intimately connected with the shadow banking system. For example, money from commodities is sometime reloaned to developers in a real estate market that is slowing. The fall of one domino could reverberate throughout the system. The Qingdao issue may be small, but it represents standards of lending throughout China.


It is a question of risk. In the present loose money environment that permeates the entire global financial system, lenders ignore it. They are very lax when it comes to risk assessment, especially if there is any reasonable yield. They tend to overlook or waive the legal safeguards normally used to protect themselves. If these loans go bad, the probability of attaching the collateral in most emerging markets is exceptionally difficult even if there isn’t any fraud. In developed markets, covenant lite or cov-lite lending has reached record levels, higher than in 2007. Lenders, even when they could avail themselves of protection, don’t require it.


If banks or other lenders start to ask questions they are likely to tighten up on lending. Since many businesses and even local governments in China are sitting on a pile of debt, failure to access even more credit will feed on itself. Fear of being the last creditor to attach collateral is just the first step.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)


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