Dividend

Meaning of dividend

• A share of the after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them.

• The amount and timing of the dividend is decided by the board of directors, who also determine whether it is paid out of current earnings or the past earnings kept as reserve. Holders of preferred stock receive dividend at a fixed rate and are paid first. Holders of ordinary shares are entitled to receive any amount of dividend, based on the level of profit and the company's need for cash for expansion or other purposes.

Provisions governing declaration and payment of dividend

• The provisions governing declaration and payment of dividend by a company are provided in the Companies Act, 1956 (referred to as “Act”) and the Rules made there under including the Companies (Transfer of Profits to Reserve) Rules, 1975, Companies (Declaration of Dividend out of Reserves) Rules, 1975.

• The Companies Act allows dividends to be paid out of three sources namely

(a) Profits of the company for the year for which dividends are to be paid. (b) Undistributed profits of the previous financial years. (c) Moneys provided by the Central Government or a State Government for

the payment of dividends in pursuance of a guarantee by the Government concerned.

Determination of Dividend • Section 205 of the Act only prescribes that dividend shall be paid out of profits of the

company. As dividends can only be declared out of surplus earnings, there must be an exact method of determining whether surplus earnings for that purpose actually exist.

• But the Companies Act do not provide any guidance in this regard. There is nothing at all in the Act about how dividends are to be paid, nor how profits are to be reckoned; all that is left and very judiciously and properly left, to the commercial world.

• Further, it has become obligatory for a company to provide for depreciation as required by Section 205(2) of the Act. Depreciation has to be provided for the current year as well as for arrears of depreciation if any. It further states that the depreciation is to be calculated at the rate specified in Schedule XIV of the Act. Further, it is to be noted that if the Act makes no provision for a particular kind of asset, then its depreciation may be worked out on a basis approved by the Government in this regard.

• A company has got two choice to arrive at depreciation i.e. either to adopt the above said procedure or to work out depreciation by dividing ninety five percent of the original cost of the depreciable asset by the specified

• But, if any asset is sold, discarded, demolished or destroyed for any reason before depreciation for such asset has been provided for in full, the excess, if any of the written down value of such asset over its sale proceeds or its scrap value shall be written off in the financial year in which it is sold. It is to be noted that the Act does not require any provision to be created for depletion of a wasting asset.

• Further, the previous years’ losses, if any must also be set off against the profits of any subsequent year or years before any dividend can be paid.

• The provison (c) of Section 205(1) of the Act empowers the Central Government to waive in any particular case, the requirement of providing for depreciation. The word loss also includes depreciation (as declared in the case of Garden Silk Weaving Factory Vs. CIT (1991) SC). There is no reason to give the word “loss” as used in Section 205 a different meaning from one in which it is ordinarily understood only because it has to be read with Section 115 of the Income Tax Act, 1961 (V.V.Trans-Investments (P) Ltd Vs CIT (1999) SC)

Declaration of Dividend

• A company cannot declare dividend in the following circumstances:-a) When a Company is not having profit i.e. is a loss making company.b) When a Company fails to redeem its preference shares as per the provisions

of Section 80A of the Companies Act. (Sub Section 2B) • Further, a Company cannot declare a dividend without the prior approval of

Financial Institution, in case if the agreement of the loan contract stipulates in this regard. Section 205(3) stipulates that no dividend shall be payable except in cash.

• Dividends cannot be declared out of the Securities Premium Account or the

Capital Redemption Reserve Account or Revaluation Reserve or Amalgamation Reserve or out of the Profit on re-issue of forfeited shares or out of profit earned prior to the incorporation of the Company.

Compulsory Reserves

• Section 205 (2A) of the Act prescribes that before any dividend is declared or paid, certain percentage of profits as may be prescribed by the Central Government, but not exceeding 10% will have to be transferred to the reserves of the Company. The company may, however, voluntarily create more than the prescribed percentage and transfer to the reserves of the Company. If in a particular year, on account of inadequacy of profit, the company has to pay dividends out of the previous year’s reserves, it should follow such rules as may be made by the Central Government. In case of any deviation from such rules, then the company can do so only with the previous approval of the Central Government.

• The term “Reserve” meant in the said Rules means “Free Reserves” i.e. reserve which are not created or set apart or intended for any special purpose. For e.g. Development Rebate Reserve, Capital Reserve or Special Reserve will not come under the category of free reserves for the purposes of this rule.

According to the Companies ( Transfer of Profits to Reserves) Rules 1975, before declaration or payment of dividend, profits shall be compulsorily transferred to reserves at the following rates:-Rate of proposed dividend

Amount to be transferred to Reserves

Not exceeding 10% Nil

Exceeding 10% but not exceeding 12.5% 2.5% of current profits

Exceeding 12.5% but not exceeding 15% 5% of current profits

Exceeding 15% but not exceeding 20% 7.5% of current profits

Exceeding 20% 10% of current profits.

Capitalization of Profits

• The proviso to Section 205 further states that there is no prohibition for capitalization of profits or reserves for the purpose of issuing fully paid up bonus shares or paying up any amount for the time being unpaid on any shares held by the members of the company.

• Thus, a company may in general meeting, on the recommendation of the Board of Directors resolve and convert into capital any sum standing to the credit of profit or loss account or reserve fund account or otherwise available for distribution. As a general rule only such funds can be capitalized as would be available for dividend distribution.

Entitlement -Equity Shareholders

• A company can pay dividend only to the shareholders of that company :-

a) whose name appears on the Register of members maintained by the Company (in case the shares are held in physical form) or

b) whose name appear on the register of beneficial owners maintained by a depository (in case the shares are held in dematerialized form)

Preference shareholders

(a) Preference shares carry a preferential right as to dividend in accordance with the terms of the issue and the Articles, and hence preference shareholders are paid dividend before the dividend is paid to the equity shareholders of the company.

(b) Preference shares may be cumulative or non-cumulative. Dividend in arrears on cumulative preference shares can be paid in the subsequent years where there are profits sufficient for such payment. In case of non-cumulative preference shares, if no dividend is paid in a year, there is no right to receive it in future years.

• Further if any shares are delivered to a Company or registration and the same have not been registered by the Company then any dividend to be paid on those shares need to be transferred to the unpaid dividend account.

Procedure for declaration of Dividend

• A company which intends to declare and pay dividend should adopt the following procedures. Further, in case the company’s shares are listed on the Stock Exchanges, additional requirements relating to Listing Agreements are to be followed.

1) Recommendation by Board of Directors:-

•Dividend can be declared only on the recommendation of the Board of Directors of the Company. The shareholders do not have any power to declare any dividend. The Board of Directors after considering and approval of the financial statements of the Company, determines the rate of dividend to be declared and then recommends the same to the shareholders. For this purpose, a Board Meeting shall be convened to pass the resolution for•a) rate of dividend and the amount of dividend to be paid. b) book closure DATE FOR dividend purposes c) DATE of annual general meeting d) Bank with which the account shall be opened for the purpose of remittance of dividend.

2) Approval by the Shareholders:-

•The dividend recommended by the Board of× Directors is declared by a resolution passed at the Annual General Meeting by the shareholders. The declaration of dividend should form part of an ordinary business item to be transacted in the notice of the Annual General Meeting. While approving the rate of dividend at the Annual General Meeting, the shareholders have power to declare a lower rate of dividend than what is recommended by the board but they have no power to increase the amount or the rate of dividend so recommended by the Board of Directors. Dividend when declared becomes debt against the company.

3) Dividend now includes interim dividend:-

•After the Companies (Amendment) Act, 2000, interim dividend is now recognised as a part of final dividend (clause 14A of Section 2). Interim dividend can be declared by the Board of Directors and they have authority to do so. Further, the provisions contained in Section 205, 205A, 205C, 206, 206A and 207 shall apply to interim dividend.

4) Dividend to be deposited in a separate bank account:-•The Company should deposit the dividend amount ( including interim dividend) within 5 days of its declaration in the separate bank account opened for this purpose. It means that the interim dividend will have to be deposited in a bank account within 5 days of the× Meeting whereas final dividend will have to be deposited within 5 days from the DATE of× Meeting in which it was approved by the shareholders. Also Section 205 (1B) stipulates that the amount so deposited shall be used only for the purpose of payment of dividend ( whether interim or final).

5) Dividend to be paid by cheque or warrant

•Section 205(5)(b) of the Companies Act, 1956 provides that the dividend payable in cash may be paid either by cheque or warrant.

6) Time frame for payment of dividend

•As per Section 207 of the Companies Act, 1956, the dividend warrants shall be dispatched within 30 days of declaration of dividend.

7) Transfer of unpaid dividend

• As per Section 205A of the Act, where a dividend has been declared by a company but has not been paid (or claimed) within 30 days from the date of declaration to any shareholder entitled to the said payment of dividend, the× Company shall within 7 days from the expiry of the said period of 30 days transfer the total amount of dividend which remains unpaid or unclaimed within the said period of 30 days to a special account to be opened by the× Company in that behalf with any Scheduled Bank which is called “unpaid Dividend Account of ----- company Limited. Interest at the rate of 12% p.a. is payable by the Company for delay in making the above transfer.

8) Transfer of unpaid or unclaimed dividend to the× Education and Protection Fund:-

•Any amount of dividend which remains unpaid or unclaimed for a period of 7 years from the date it became due for payment shall be transferred by the company to the Investor Education and Protection Fund. When making a transfer to the× Fund, the Company shall furnish to the authority appointed by the× Government, the details relating to a) all sums included in such transfer b) nature of the sums, c) names and last known addresses of the PERSONS entitled to receive the sum. D) the amount to which each person is entitled and such other particular as the case may be prescribed. The said fund shall be utilised for promotion of investor awareness and protection of the interests of investors in accordance with the Investor Education and Protection Fund Rules, 2001

•Further as per Section 205B of the Act, once any amount on account of unpaid / unclaimed dividend has been transferred to the Investor Education and Protection Fund in pursuance of Section 205C, no claim, for payment for any sum, from any PERSON shall be entertained by the Fund. Thus, any person claiming to be entitled to any dividend

• Section 217(1)(c) of the Companies Act, 1956 requires that the report of the Board of directors shall state the amount, if any, which it recommends should be paid by way of dividend. The Board may choose not to declare any dividend even though the company has made profit and the same be captured in the Directors Report with reasons.

Compliance relating to Listing Agreement• 1) Clause 12A

– 4)As per this clause, the company should adhere to the provisions of Section 206A as well as Section 27 of the Securities Contracts (Regulations) Act, 1956, wherein it is the duty of the company to keep dividend, offer of rights shares and bonus shares in abeyance in a situation where such dividend, right etc. are declared in the interval between lodgement of a valid instrument for transfer of shares with the company and its eventual registration.

• 2) Clause 16– The Company agrees to close its transfer books for the purpose of declaration of dividend and will give notice to the Stock Exchange

at least 7 working days in advance of the DATE of closure of transfer books and will also intimate the purpose for which the transfer books are closed. Regarding the book closure, advertisement should be issued in the newspapers and copies of such advertisements shall be sent to Stock Exchanges ( As per Section 154 of the Companies Act, 1956).

• 3) Clause 19 :-– The company will give prior intimation to the Stock Exchange about the Board Meeting at which proposal for recommendation

odividend and or passing over of dividend due to be considered at least 2 working days in advance. Further, the Company will recommend or declare dividend at least 5 days before commencement of the closure of its transfer books.

• 4) Clause– 20AThe company agrees to declare and disclose the dividend on per share basis only.

• 5) Clause 21– The Company will fix and notify the× Exchange at least 21 days in advance of the DATE on from which the dividend on shares will be

payable and will issue simultaneously the dividend warrants/cheques which shall be payable at par at such centres as may be agreed to between the× Exchange and the Company and which shall be collected at par, with collection charges, if any, being borne by the× Company, in any bank in the country at centres other than the centres agreed to between the Exchange and the company so as to reach the holders of shares on or before the date fixed for payment of dividend.

• 6) Clause– 28AThe Company agrees that it shall not issue shares in any manner which may confer on any person, superior rights as to voting or

dividend vis-à-vis the rights on equity shares that are already listed.

• 7) Clause– 34The Company agrees that it will not forfeit unclaimed dividends before the claim becomes barred by law and

that such forfeiture, when effected will be annulled in appropriate cases. Further, the× Company agrees that if any amount be paid up in advance of calls on any shares, it will stipulate that such amount may carry interest but shall not in respect thereof confer a right to dividend or to participate in profit.

– 8) Clause 41In respect of requirements as to financial figures, the Company shall disclose the following to the Stock Exchanges, the dividends paid or recommended for the year, including interim dividends:-

– a) the amount of dividend distributed or proposed for distribution per share and the amounts in respect of different classes of shares shall be distinguished and the nominal values of shares shall also be indicated.

– b) Where dividend is paid or proposed to be paid pro-rata for shares allotted during the year, the date of allotment and number of shares allotted, pro-rata amount of dividend per share and the aggregate amount of dividend paid or proposed to be paid on pro-rata basis.

– 49n respect of complaint received from any shareholder regarding non-receipt of dividend, a board committee under the chairmanship of a non-executive director shall be formed to specifically look into the redressal of shareholder. This Committee shall be designated as ‘Shareholders/Investors Grievance Committee’. Further, under the matters to be placed before the Board Meeting, one of the item is to place the non-compliance relating to payment of dividend. Hence a listed company will have to compulsorily place before the Board of Directors any grievances relating to shareholders with respect to non-payment of dividend.

• 9) Clause – 49n respect of complaint received from any shareholder regarding non-receipt of dividend, a board committee

under the chairmanship of a non-executive director shall be formed to specifically look into the redressal of shareholder. This Committee shall be designated as ‘Shareholders/Investors Grievance Committee’. Further, under the matters to be placed before the Board Meeting, one of the item is to place the non-compliance relating to payment of dividend. Hence a listed company will have to compulsorily place before the Board of Directors any grievances relating to shareholders with respect to non-payment of dividend.

• 10) Sharehlders’ Information under Corporate Governance Report– Under the Corporate Governance Report, the dividend payment date should be mentioned under the heading “

Shareholders’ Information”.

Interim Dividend –Whether a statutory debt

• The declaration of an interim dividend does not create a debt against the company. Dividends can be declared only by a resolution of the shareholders in accordance with the Directors’ recommendation at a general meeting. But, if so permitted by the Articles of Association of the company, the Directors can declare an interim dividend between two Annual General Meetings. While declaring interim dividend, the Board should carefully assess and examine the FINANCIAL statements and should ensure that the company has adequate profits. However, it does not create a debt enforceable against the company, because, the Directors can very well rescind the resolution before payment. Thus, the shareholders do not get any vested right under a Directors’ resolution declaring an interim dividend.

• It is to be noted that Section 207 of the Companies Act which applies to interim dividend also, stipulates penalty for failure to distribute dividend to the shareholders within 30 days of its declaration. The penalty prescribed under the Act is that the directors shall be punishable with simple imprisonment of three years along with a fine of Rs.1000 for every day during which such default continues and the company shall be liable to pay simple interest at the rate of 18% p.a. during the period for which such default continues. Further, since the penalty prescribed is by way of both fine and imprisonment, the offence is also not compoundable under Section 621A of the Companies Act.

• Thus, going by the principle, in law one cannot take advantage of his own default, the Board of Directors have got power to rescind the payment of dividend only upto the 29th day of its declaration and not thereafter. It is because, after the 30th day, it becomes a statutory default.

• Clause 110(3) of the Companies Bill, 2009 also stipulates that the board of directors of a company may declare interim dividend during any financial year out of the profits of the company for part of the year.

When dividend need not be paid:-

In the following cases, a company need not

pay dividend within 30 days from the date of declaration:-

a) Where dividend could not be paid by

reason of the operation of any law.b) Where a shareholder has given directions

to the company regarding payment of dividend and those directions cannot be complied with.

c) Where there exist a dispute regarding the right to receive the dividend.

d) Where dividend is lawfully adjusted by the company against any sum due to its from the shareholder.

e) Where the non-payment of dividend is not due to any default of the company.

Disqualification for directors:-

• As per Section 274 (1)(g) of the Companies Act, 1956, if a public company fails to pay dividend and such failure continues for one year or more, then any person who is a director of the company at the time when default is made, shall not be eligible to the appointed a director of any other public company for a period of 5 years.

Conclusion

The payment of dividend will instill confidence to the shareholders of the

company, after all a company can declare and pay dividend only if it makes profit. Further, payment of dividend consistently over a period of time would enhance the image of the company. The company would also stand to benefit as whenever it requires additional funds for expansion, it can very easily tap the capital markets (as investors would be ready and willing to invest) without resorting to huge borrowings from Banks and Financial Institutions.

The shareholders can be rewarded by other means i.e. declaring bonus shares, rights shares etc. but since dividend is PAID IN CASH it is considered one of the best reward a company can do to its shareholders for enhancing their wealth. The shareholders also enjoy additional benefit since the dividend which they receive is tax free and need not pay any tax on dividend and the company would be liable to pay Dividend Distribution Tax. Thus, a consistent dividend paying company is considered to be a good investment option to the investors.

THANKS

Yakshika Vats