A company may distribute a part of the profits which it has earned as dividend to its shareholders. No dividend can be declared or paid by a company for any financial year out of its profits except after transfer to the reserves of the company of such percentage of its profits for that year as may be prescribed, the maximum being 10 per cent.

Dividend may be declared only out of the following sums: -
1. Out of the profits of the company for that year after providing for depreciation

2. Out of the profits of the company for the previous financial year or years arrived at after providing for depreciation and remaining undistributed

3. Out of moneys provided by the Central or State Government for the payment of dividend pursuant to a guarantee given by that Government.

Depreciation : Under Section 205(2) depreciation should be provided in one of the following ways before arriving at the distributable profits: -  

1. Written down value method: or

2. Straight line method: or

3. Any other method approved by the Central Government; or

4. In respect of depreciable assets where no rate of depreciation has been provided in this Act or any rules made there under, on such basis as is approved by the Central Government.

In the case of 2 and 3 above, the rate should be worked out in such a way that during the specified period of the asset, at least 95% of the value of the asset should be written off. Under Section 205(5) specified period in respect of any depreciable asset shall mean the number of years at the end of which at least ninety five per cent of the original cost of that asset to the company would have been provided for by way of depreciation if depreciation were to be calculated in accordance with the provisions of Section 350.

Transfer to Reserve:
No dividend can be declared by a company for any financial year except after transfer to reserve of the company of such percentage of its profits for that year, not exceeding 10 per cent as may be prescribed. On exercise of their power under this sub-section the Central Government have promulgated the Companies (Transfer of Profits to Reserves) Rules, 1975 prescribing the percentages of profits to be transferred to reserve before declaring dividend. The following percentages of profit will have to be transferred before a dividend is declared: -

No dividend can be declared by a company for any financial year except after transfer to reserve of the company of such percentage of its profits for that year, not exceeding 10 per cent as may be prescribed. On exercise of their power under this sub-section the Central Government have promulgated the Companies (Transfer of Profits to Reserves) Rules, 1975 prescribing the percentages of profits to be transferred to reserve before declaring dividend. The following percentages of profit will have to be transferred before a dividend is declared: -

(a) If the proposed dividend exceeds not less than 2.5% of the current 10% but does not exceed 12.5% of profits the paid-up capital

(b) If the proposed dividend exceeds not less than 5% of the current 12.5% but does not exceed 15% of profits the paid-up capital

(c) If the proposed dividend exceeds not less than 7.5% of the current 15% but does not exceed 20% of profits the paid-up capital

(d) If the proposed dividend exceeds not less than 10% of the current 20% of the paid-up capital profits.

Dividend in Case of Absence or Inadequacy of Profits:
In case of absence or inadequacy of profits dividend can be declared under Section 205A(3) of the Act out of the accumulated profits earned by the company in the previous years and transferred by it to reserves. Such declaration should be in accordance with the rules prescribed in this regard by the Government. If such a declaration does not conform to the rules, the declaration of dividend will require the previous approval of the Central Government. In exercise of their powers, the Central Government have formed rules known as Companies (Declaration of Dividend out of Reserves) Rules, 1975. Under these rules dividend can be declared from amounts drawn from reserves in case of absence or inadequacy of profits subject to the following conditions: -

In case of absence or inadequacy of profits dividend can be declared under Section 205A(3) of the Act out of the accumulated profits earned by the company in the previous years and transferred by it to reserves. Such declaration should be in accordance with the rules prescribed in this regard by the Government. If such a declaration does not conform to the rules, the declaration of dividend will require the previous approval of the Central Government. In exercise of their powers, the Central Government have formed rules known as Companies (Declaration of Dividend out of Reserves) Rules, 1975. Under these rules dividend can be declared from amounts drawn from reserves in case of absence or inadequacy of profits subject to the following conditions: -

1. The rate of dividend declared shall not exceed average of the rates of dividend declared by it during the immediately preceding last five years or 10% of the paid-up capital, whichever is less:

2. The amount to be drawn shall not exceed 10% of its paid-up capital and free reserves and the amount so drawn should be first utilized to set of the losses incurred in the financial years: and

3. The balance of reserves after such withdrawal shall not fall below 15% of the paid-up share capital.