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Declaration and Distribution of Dividends by a Company

Written by: Tulika Sinha & Shashank Bijapur - Final Year Students of HNLU
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Background
The purpose of this article is to enunciate the procedure for declaration and distribution of dividends by a company under the Companies Act, 1956 (the “Act”). In putting this article together, an effort has been made to identify the preliminary questions often asked at the outset. It is not to provide a detailed analysis as the details may vary from case to case.

2. Meaning
Dividend is the return on the investment made in the shares (equity or preference) and is paid out of the profits of the company. The shareholders being the owners of the company are entitled to get their share of profit in the form of dividend. While the rate of dividend in case of preference shares is fixed, the dividend on equity shares varies from year to year depending upon the profit for the year and the requirement to get back profits. Dividend rate is used for valuation of share and is an indicator of performance of the company.

3. Legal Regime

Section 205 of the Act regulates the declaration and distribution of dividend. All the companies which have share capital other than section 25 companies and make profit are bound by law to declare and distribute dividends. As per Section 205 of the Companies Act, 1956, a dividend (including interim dividend) can be paid out of current profits or profits accumulated of earlier years. However, depreciation for the entire year has to be provided before a dividend is declared or paid. For this purpose, the Board needs to approve the provisional financial results (unaudited) and a working of the profits available for distribution as dividend, post providing for depreciation for the full year and amount required to be transferred to reserves as per the Companies.[1] Sections 205 A, B and C deal with some other aspects of distribution of dividend such as establishment of Investor Education and Protection Fund, Payment of unpaid and unclaimed dividend etc.
Separate bank account needs to be opened and the amount of dividend will have to be transferred to that account. Dividend will have to be remitted within 30 days of declaration. The other procedure of record date/book closure, payment of tax on dividend within 7 days of declaration, etc. will have to be complied with.Dividend is also payable out of divisible profits or out of moneys provided by the Central or any State Government for the payment of dividend in pursuance of a guarantee given by that Government.

4. Mode of declaration

Dividend can be declared out of four sources. Firstly It can be declared out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of the Act or secondly, out of the profit of the company for any previous financial year or years arrived at after providing for depreciation in accordance with those provisions and remaining undistributed or thirdly, out of both or lastly, out of the money provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by that Government.

5. Prohibition

A company which has failed to redeem the irredeemable preference shares within the stipulated time cannot declare dividend.

6. Steps involved in the process of declaration and distribution of dividend

6.1 Computation of Depreciation

Depreciation shall be provided either at the rate specified in Schedule XIV or any other basis approved by the Central Government.

6.2 Compulsory Transfer of Profits to Reserves

Before declaring the dividend, the some part of the profit has to compulsorily transferred to the Reserves of the Company. This amount is based on the proposed rate of dividend.[2] However voluntary transfer of higher percentage to reserves is permitted subject to the conditions stipulated in the Act.

6.3 Board Resolution

The most important step in the process is the Board Resolution for declaration of dividends. Unless the Board recommends the payment of dividend, the same cannot be declared at an Annual General Meeting.

6.4 Annual General Meeting (“AGM”)

The item pertaining to declaration of dividend should be included in the agenda of the notice for AGM which should be sent to members as well as the creditors. An ordinary resolution is required for declaration of dividend. However shareholders cannot increase the amount of dividend recommended by the Board.

6.5 Time Limit for payment of Dividend

The dividend account should be opened with the company’s bankers and the dividend amount payable should be transferred to that account. Within 30 days of the AGM the dividend warrants should be sent to the shareholders.

6.6 Transfer to unpaid dividend account

Within 7 days from the date of expiry of 30 days from the date of dividend declaration, the amount remaining unpaid or unclaimed should be transferred to the ‘unpaid dividend account’ to be opened in a scheduled Bank. Dividend which remains unpaid or unclaimed for a period of 7 years shall be transferred to the Investor Education and Protection Fund within a period of 30 days of its becoming due for the transfer.[3]

7. Circumstances under which dividend need not be paid:

a. Where it could not be paid because of operation of any law;
b. Where a shareholder has given direction to the company regarding payment of dividend and those directions could not be complied with;
c. Where there is a dispute regarding the right to receive the dividend;
d. Where the dividend has been lawfully adjusted by the company against any sum due from the shareholders; and
e. Where the dividend could not be paid not due to any default on part of the company.

8. Tax Limit

In addition to the income tax chargeable in respect of the total income of a company for any assessment year, any amount declared, distributed or paid by such company by way of dividends (whether interim or otherwise) and also whether paid out of current or accumulated profits is charged with additional tax at the rate of 15 %.[4] The liability of payment of tax is on the principle officer of the company. The tax has to be paid within 14 days of declaration, distribution or payment of any dividend whichever is the earliest. The tax on distributed profit paid by the Company would be treated as the final payment of tax in respect of dividend.

9. Special Provisions relating to Listed Company

In addition to the steps mentioned above the listed companies also have to advance intimation regarding the venue of the Board Meeting to the stock exchange where the securities are listed. Within 15 minutes of the closure of the Board meeting, intimation is also to be sent to the stock exchange containing the particulars of dividend. Details regarding the general meeting for the declaration of dividend are also to be given to the Stock Exchange.

10. Conclusion
These are the various steps which are usually involved in the declaration and distribution od dividend by a company incorporated under the Act. However depending upon the facts and the memorandum and articles of the company there might be some variation or addition to these steps.

End-notes
[1] (Transfer of Profits to Reserves) Rules, 1975
[2] The Companies (Transfer of Profits to Reserves) Rules, 1975 set out different thresholds/limits for the percentage of profits to be transferred to reserves depending upon the extent of the dividend proposed to be paid. Under the said Rules, if the proposed dividend exceeds 20% of the paid-up capital, the amount to be transferred to reserves should be at least 10% of the current profits. The Company has informed us that they have applied this threshold in arriving at the amount of INR 20 crores and have assumed, for such computation, that the profits (net of tax) for the entire year would be approximately INR 200 crores.
[3] Governed by Investor Education and Protection Fund (Awareness and Protection of Investors) Rules, 2001 and section 205 C of the Act
[4] Excluding surcharge and cess (which may vary every financial year)

The author can be reached at: tulikasinha@legalserviceindia.com / Print This Article

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