# Declaration of Dividend out of Free Reserves — Rule 3 of Companies (Declaration and Payment of Dividend) Rules, 2014
Where a company has inadequate or no profits in the current year but still wishes to declare a dividend, it may draw on the accumulated profits transferred to free reserves, subject to four cumulative conditions.
## The Four Conditions — All Must Be Satisfied
### Condition I — Cap on Rate
The rate of dividend shall not exceed the average rate at which dividend was declared in the immediately preceding 3 financial years.
$$\text{Rate of Dividend} \leq \frac{RD_1 + RD_2 + RD_3}{3}$$
Exception: If no dividend was declared in any of the preceding 3 years, this cap does NOT apply.
### Condition II — Cap on Quantum
The total amount drawn from accumulated profits shall not exceed 10% of (Paid-up Share Capital + Free Reserves) as per the latest audited financial statement.
### Condition III — Set Off Current Year's Losses First
The amount drawn shall first be utilised to set off the losses incurred in the financial year in which dividend is declared. Only the balance can fund the dividend.
### Condition IV — Minimum Residual Reserves
After withdrawal, the balance of free reserves shall not fall below 15% of paid-up share capital (as per latest audited financial statement).
## Exemption — 100% Government Companies
These four conditions do NOT apply to government companies in which the entire paid-up share capital is held by:
- The Central Government, or
- One or more State Governments, or
- Both the CG and any SG(s).
## Logic
Rule 3 exists to balance two competing interests:
- Shareholders' expectation of dividend continuity even in a lean year,
- Creditor protection by preventing reserves from being drained.
The four conditions act like guardrails: rate cap, quantum cap, current-year loss absorption, and a permanent reserves floor.
## Key Takeaway
Remember the 3-10-15 rule of thumb: 3-year average rate cap, 10% of (PUSC + Free Reserves) maximum withdrawal, 15% of PUSC minimum reserves remaining.