When “Profit” Isn’t Always Distributable

– Understanding Reportable vs Distributable Profits under Ind AS and the Companies Act, 2013

– Sourish Kundu | corplaw@vinodkothari.com

In the sphere of corporate law intertwined with accounting principles, there arises a question on profits that are reported in the financials of a company and the amount that can actually be distributed, that is to say, a company’s reported profits may be impacted by several accounting standards, yet that does not mean it can distribute all of that profit as dividends. Under Indian law and accounting rules, there is a clear distinction between reportable profits (what appears in the financial statements) and distributable profits (what a company is legally permitted to pay out to shareholders). In this article, we decode the difference between reportable profits and distributable profits and the implications of this difference, whether companies are expected to prepare two statements of profit or loss, how investors are expected to read the financials to ascertain what can be expected as dividend. 

What are Reportable Profits?

“Reportable profits” refers to the profits (or loss) shown in the Statement of Profit & Loss prepared under Indian Accounting Standards (Ind AS). It includes all recognised items of income, expenses, gains and losses, whether realised or unrealised, so long as they meet the recognition and measurement rules in terms of the relevant accounting standards. For example, under Ind AS 109 (Financial Instruments), paragraph 5.7.1 states that changes in fair value of financial assets or liabilities measured at fair value through profit or loss (FVTPL) must be recognised in the PnL. Similarly, fair-value measurement principles under Ind AS 113 (Fair Value Measurement) apply where other Ind ASs require or permit fair value. 

Because reportable profits include unrealised fair value gains, remeasurements, or other accounting adjustments, there is always a possibility of an inflated or deflated picture being painted wherein there is a difference between a company’s “profit” number from the perspective of distribution.

What are Distributable Profits?

“Distributable profits” are that portion of profits (or reserves) out of which a company can legally declare and pay dividends to its shareholders under the Companies Act, 2013. Section 123(1) of the Act states that a company shall not declare or pay any dividend for a financial year except:

• out of the profits of the company for that year, after providing for depreciation, and
• out of the profits of any previous financial years, after providing for depreciation and remaining undistributed.

The first proviso to section 123(1) further clarifies that unrealised gains, notional gains or revaluation surplus arising from measurement at fair value shall not be treated as realised profits for the purpose of dividend declaration. 

“Provided that in computing profits any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value shall be excluded”

Thus, even though accounting standards allow recognition of such gains/losses in the PnL statement, the law restricts their distribution and ensures distribution can be made of only actual realised profits.

As per the section, following adjustments are required to be made to reportable profits to compute distributable profits

Reportable Profits	XXX
Less:
(b) unrealised gains	(XXX)
(c) notional gains	(XXX)
(d) revaluation of assets (positive)	(XXX)
(e) any change in carrying amount of assets (positive) on measurement at FV	(XXX)
(f) any change in carrying amount of liability (reduction) on measurement at FV
Add:
(a) revaluation of assets (negative)	XXX
(b) any change in carrying amount of assets (reduction) on measurement at FV	XXX
(c) any change in carrying amount of liability (increment) on measurement at FV	XXX
Distributable Profits	XXX

So effectively, it is not the case that companies need to maintain or prepare parallel PnL, one for the accounting purpose and one for the purpose of ascertaining distributable profits, the adjustments as illustrated above needs to be carried out. This is similar to adjustments carried out for the purpose of ascertaining profits in terms of Section 198 of the Companies Act, 2013, which is broadly used for determining CSR expenditure and the limits of managerial remuneration. Interestingly, the treatment of fair value changes in assets and liabilities is akin to how it is treated here, that is, fair value gains are not given credit and hence reversed, and on the other hand, fair value losses are not deducted and hence added back to arrive at the figure out of which managerial remuneration is to be paid, or CSR expenditure is required to be made. 

Some examples of such fair value changes and their impact on the reportable and distributable profit figures are given below: 

Examples: 

Consider the following scenarios for company following Ind AS principles of accounting: 

1. Treatment of FVTPL

Date	Particulars	Value	Reportable Profits	Distributable Profits
July, 2024	Acquisition of investment	Rs. 100	–	–
31st March, 2025	Value of investments	Rs. 150	50 (represents fair value gains routed through PnL)	–
January, 2026	Sale of investments	Rs. 200	–	100 (realised gain)

2. Deferred Tax Asset

Date	Particulars	Value	Reportable Profits	Distributable Profits
July, 2024	Acquisition of investment	Rs. 100	–	–
31st March, 2025	Value of investments	Rs. 70	-30 (represents fair value loss routed through PnL)	–
	Deferred tax asset	Rs. 9 (30% tax on Rs. 30)	9	–
January, 2026	Sale of investments	Rs. 90	–	-10

Why the Difference Exists

The divergence arises because accounting standards and company-law provisions serve different purposes:

• The Ind AS framework aims to present true and fair information about an entity’s financial performance and position, which includes remeasurements and accounting for fair value changes.
  
• The company law legislation aims to protect the company’s capital base and ensure dividends are paid out of “real” profits, thereby protecting creditor interests and preventing erosion of capital.

Thus, distributing unrealised or notional gains could expose the company (and its creditors) to risk if those gains reversed. The legal restriction is a form of capital maintenance concept.

Conclusion

In sum: reportable profits (what Ind AS shows) is not always the same as distributable profits (what a company can legally pay out). The presence of items such as unrealised fair-value gains, which are recognised in profit but not “realised” and hence, not available for distribution under company law, creates this difference. Understanding this distinction is essential because in the end, the dividend cheque flows only from the legally distributable pool and not simply from what the profit and loss account might suggest.

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