This article is written by Anjali Sinha, a legal professional. The article provides a detailed analysis of dividends, their sources, declaration, exceptions and supporting case laws. Further, it describes the declaration of dividends in connection with the Companies (Declaration and Payment of Dividend) Rule.
This article has been published by Sneha Mahawar.
Dividends can be paid out of profits from the current year, profits from prior years, or both. Let’s say that even if a company has lost money this year, it can still pay dividends if profits from previous years haven’t been distributed.
Additionally, dividends may be paid out of the profits made in the current year even if the company has a negative balance in its profit and loss account at the beginning of the current year and earns a profit in that year, but the profit is insufficient to cover the losses of the previous year (i.e., the profit and loss account shows a negative balance after accounting for the profit of the current year).
Also, in case of non-payment of dividends shall be administered by SEBI in the case of listed public companies and public companies intending to list their securities on any recognized stock exchange in India.
Meaning of dividend
The dividend is the return on the share capital that shareholders subscribe to and pay to a company. Section 2(35) of the Companies Act of 2013 defines the term ‘dividend’ as “dividend includes any interim dividend”. A dividend, according to the dictionary, is a sum paid to creditors of an insolvent estate or an individual’s share of it as loan interest or profit. However, in business parlance, a dividend is the portion of the company’s profit distributed to its members.
There is a very minute difference between an interim dividend and a final dividend. While a final dividend is a liability for the company and can be enforced once it is declared by members of the general meeting, a declaration of an interim dividend by the board does not create a liability and can be cancelled at any time before the interim dividend is actually paid out. Even if a portion of the interim dividend has been deposited into a separate bank account, the cancellation can still be performed. The board has the authority to declare an additional interim dividend, and the interim dividend is not subject to the approval of the members at the general meeting.
According to clause 81 of Table F of the Companies Act of 2013, the board may, subject to Section 123, pay interim dividends to members as it deems appropriate in light of the company’s profit.
However, the Department of Company Affairs issued a position regarding interim dividends, stating that the general meeting has the authority to approve dividends, and the board can pay interim dividends if authorised by the articles of association, subject to the company regularising interim dividends at the general meeting. However, these are not legally binding.
Declaration of dividend
No specific power has been granted to the companies registered under the act to declare and pay any dividend. The power to pay dividends is a permanent existing characteristic in a company that is neither derived from the Companies Act, 2013 nor from the Memorandum of Association or Articles of Association. However, the manner in which the dividends are to be declared is regulated by the Articles of Association.
Clause 1 of Section 123 provides sources through which dividends can be declared or paid by a company. (Discussed in detail below).
Clause 2 of Section 123 provides that in accordance to Schedule II, depreciation shall be disbursed.
Clause 3 of Section 123 provides that the Board of Directors of a company may declare an interim dividend from the surplus in the profit and loss account or from profits generated in the current financial year, provided that it does not exceed the average dividend declared by the company during the preceding three financial years.
Clause 4 of Section 123 provides that the amount of the dividend must be deposited into a separate bank account within five days from its declaration.
Clause 5 of Section 123 provides that it must be paid out to the registered shareholder, and should be given in cash. A bonus issue may be issued if approved, but cash dividends can also be paid by cheque, or electronic means.
Clause 6 of Section 123 provides that if any provisions of Section 73 and 74 are not met, then no equity dividend can be declared until full compliance is resumed.
Dividend on preference share
Subject to the availability of distributable profits, a preference share carries a preferential dividend right in accordance with the term of issue and the articles of association. The preferential right to a dividend could be granted for a predetermined sum or a predetermined rate. It could or could not have a cumulative effect.
Prior to any dividend being paid on equity shares, preference shares may carry a fixed dividend. Shareholders of the class with priority are entitled to their preferential dividend prior to any dividend paid to shareholders of the other class if there are two or more classes of preference shares.
However, there are three conditions attached to these dividend rights.
- First, because preference shares are a part of the company’s share capital, preference dividends can only be paid if the company has made enough money.
- Second, a dividend can only be declared in accordance with the act and the company’s articles before it is distributed to shareholders.
- Thirdly, a formal declaration ought to have been made.
The preference dividend cannot be treated as a debt by preference shareholders and they cannot first sue for its payment. However, even if the preference dividend has not been declared, the preference shareholder can sue for it if the articles stipulate that the company’s profit will be used to pay the preference dividend.
Dividend on equity share
The rights of the various classes of equity shares must be taken into consideration when paying dividends on equity shares. After all dividends on preference shares have been paid, equity shareholders cannot receive dividends on their shares.
The preference dividend is fixed and cannot be increased, regardless of how large the company’s profits may be, unless the preference shares carry the right to participate in surplus profits. Even though the equity shareholder ranks second in preference to the preference shareholders, he enjoys the privilege of a higher dividend.
Therefore, with the exception of the circumstances described above, the equity shareholders may receive a dividend for the entirety of the company’s remaining profits following the payment of the preference dividend either immediately or in subsequent years.
Sources of dividend
There are three sources of dividend as per Section 123(1):
- Out of the profits of the company of the present year, after providing for depreciation.
- Out of the profits of the company for any previous financial year, after providing for depreciation.
- Any received for the payment of dividend from the Central Government or State Government.
Who is eligible to receive a dividend
A dividend on a share must be paid to the registered shareholder or his bankers. When a dividend is payable, it must be distributed within 30 days of the declaration under Section 127 of the Companies Act of 2013.
In accordance with Section 127 provision, dividends are not required to be paid within 30 days in the following circumstances:
- when a shareholder has given the company instructions regarding the dividend payment but these instructions cannot be followed;
- in cases where the right to receive dividends is in dispute;
- in cases where the dividend has been lawfully adjusted by the company to offset any shareholder-due amount.
Revocation of dividend
Once declared, a dividend, including an interim dividend, becomes a debt and cannot be revoked without shareholder approval. A dividend that is declared and distributed to shareholders cannot be altered by a subsequent resolution.
However, if a dividend was declared fraudulently, the directors would be justified in withholding the dividend. The directors are personally liable and accountable to the company if a dividend declared fraudulently is paid.
Directors, shareholders, and auditors are all responsible for improper dividend payments. In the event that an improper dividend payment results in a loss for the business, the directors are generally responsible for paying it back. They must compensate the business for the loss, for example, if they paid dividends out of capital.
On the other hand, if a shareholder knows that a dividend is paid out of capital, he or she is responsible for covering the company’s loss, and the directors can get back the dividends. The directors can be prevented from paying an improper and illegal dividend at the request of any shareholder (Hoole v. Great Western Railway Co. (1867) 3 Ch.) App. 262)
Depreciation must be provided in accordance with Schedule II in order to calculate the dividend profit. The Companies Act of 2013 mandates the inclusion of depreciation in profit calculations. However, the Companies Act of 1956 gave the central government the authority to allow dividend payments without depreciation.
In addition, the statement of profit and loss account may accept additional depreciation that is required solely as a result of asset revaluation. Therefore, the Companies Act of 2013 takes depreciation into account, which might be done to safeguard the lender’s interests.
Before declaring a dividend under the Companies Act of 1956, profits had to be transferred to the general reserve. However, the first provision to Section 123(1) of the Companies Act of 2013 states that the company can transfer profits to reserve at whatever rate it chooses before doing so.
However, despite the fact that it is not required, the board of directors is required by Section 134 of the Companies Act of 2013 to provide specifics regarding the amount, if any, that the business intends to carry into its reserve. The board of directors must also file a director’s responsibility statement in accordance with Sections 135(3) and 135(5). As a result, even though the board of directors now has the option of putting the profit into reserves, they will have to use it wisely and in the company’s best interest.
Therefore, with the exception of requiring depreciation prior to declaring a dividend, the concept of dividends has been completely liberalised, which has proven to be a legislative and judicial boon to the business sector.
Commissioner Income Tax v. Aatur Holdings P. Ltd. [(2008) 146 Comp Cas 152 (Bom)]
In this case, it was determined that a person is not entitled to the dividend simply because they may have purchased or received shares. However, the shares must not have been registered in their names in the company’s books of account. According to Section 27 of the Securities Contracts (Regulation) Act, 1956, only registered shareholders are eligible to claim dividends, and the dividends must be paid out by the company in their names.
N. Kumar v. M. O. Roy, Assistant Director, S.I.F.O [(2007) 80 SCL 55(MAD)]
In this case, a company declared a dividend on September 19, 1966, but failed to distribute it within the stipulated time frame. On August 23, 2006, a complaint was filed against the business and its directors for violating Section 207 of the Companies Act of 1956.
A director argued that because he had resigned prior to the declaration of the dividend, he could not be blamed for violating Section 207.
The court held that the director did not have full-time oversight of the company’s operations. Under Section 207, the director could not be held vicariously liable for the violation, so the proceedings were likely to be thrown out against him.
Swadeshi Cloth Dealers Ltd. v. Raghunandan Neotia (1964) 34 Comp. Cas. 570 (Cal.)
A general meeting of the shareholders was held on March 30, 1960 and during the meeting, a resolution was passed recommending dividends for different years:
- 31st March, 1961 at Rs.10/- per share.
- 31st March, 1962, at Rs. 80/- per share.
Firstly, the resolution passed and meeting held was said to be illegal and ultra vires of the Companies Act and secondly, the question arises whether the dividends could be decided only at annual general meeting?
In this case, the Calcutta High Court ruled that the Act’s provisions, taken together, require dividend declarations to be made at annual general meetings. No dividends for previous years can be declared if the amounts were closed at an earlier annual general meeting.
Kantilal v. CIT, 26 Comp. Cas. 357 (Bom.)
The Bombay High Court ruled that the law is clear and well-established that only the company’s shareholders can declare a dividend. Typically, dividend declaration provisions are included in a company’s articles. These will follow the format of Regulations 85-94 of Table “A” of the Act’s Schedule I. According to Regulation 85, the general meeting has the authority to declare a dividend, but it cannot declare a dividend greater than the amount recommended by the Board.
However, the company cannot declare a second dividend for the same year if a dividend is so declared at the general meeting. The Board of Directors is authorised to declare an interim dividend in accordance with Act under Section 205(1A). Therefore, the Board may declare an interim dividend if the articles do not expressly state otherwise.
Section 123 of Companies Act of 2013 is in connection to Section 205 of the Companies Act of 1956. It aims to say that a company must pay dividends at a general meeting for any financial year from profits from that year or any previous year or years after accounting for depreciation or from money provided by the Central Government or State Government for dividend payments. A company cannot pay dividends from reserves other than free reserves. However, a certain percentage of the profit may be transferred to the company’s reserve prior to the declaration of any dividend.
In the event of insufficient profits or no profits at all during any fiscal year, a dividend may be declared from accumulated profits transferred to reserves in accordance with the Central Government rules. According to the provision, the depreciation must be paid out in accordance with Schedule II of the Act.
Frequently Asked Questions (FAQs)
Can a dividend be paid out of the assets of the company?
Dividends cannot be paid out of the assets of the company and generally, can be declared only out of the profit available for the purpose.
What is prescribed under Schedule XIV for the rates of depreciation of various assets under the ‘straight line method’?
Schedule XIV provides the rate of depreciation of various assets under the straight line method for single shift, double shift and triple shift basis.
Can dividends be paid in cash and kind?
According to Section 205(3), dividends can be paid only in cash and not in kind.
- Taxmann’s Company Law – A Comprehensive Text Book on Companies Act 2013: Dr. G. K. Kapoor and Dr. Sanjay Dhamija – 21st Edition.
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