Out of the total profits, as disclosed by a company’s profit and loss account, determining the part of the profit (Divisible Profit) to be used for distribution amongst the shareholders as dividends is one of the most important functions of the accounts department. Arriving at that part of profit available for distribution as dividend depends upon several factors, such as their composition, amount of provisions and appropriation required to be set aside on a priority basis, etc.
The amount to be declared as a dividend is arrived at only after making appropriate provisions in respect of depreciation on assets and other intangibles not only for the accounting year to which the divisible profit pertains but any arrears of provisions/ depreciation / deferred revenue expenditures, etc. also needs to be taken into account. Such calculation is carried out under sub-section (2) of section 123 of the Companies Act, 2013.
In sub-section (3) of section 124 of the Act, the Board of Directors of a company is empowered to declare interim dividends during a financial year out of the surplus available as disclosed by the profit and loss account of that financial year. However, if a company happens to have incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of such declaration, the rate of such interim dividend should not be more than the average dividend declared by that company during the immediately preceding three financial years.
In this connection of divisible profit, it is worthwhile to underline the following facts:
- Dividends cannot be declared from any other source except from a company’s profits.
- Capital cannot be returned /distributed to the shareholders through a dividend distribution.
Payment of dividends can be made by a company only out of its profits or free reserves (excluding the amount of funds received from the Central or State Government); payment of the dividend from any other source (other than the net profits or free reserves) would be paramount to payment of the dividend from the capital.
Crucial Provisions of Payment of Dividends
Declaration of dividends form the company divisible profit and its payment by a company to the shareholders is subject to various statutory provisions. Some of the crucial provisions as stipulated under section 123 of the Companies Act, 2013 are discussed in the following points:
1) A company cannot declare/pay dividends for any financial year except:
- Out of its profits for the financial year calculated after making necessary provisions for depreciation in compliance with various conditions mentioned in Schedule II OR out of its profits for any previous financial year after making provisions for depreciation in compliance with various conditions mentioned in Schedule II, which has remained undistributed OR out of both.
- Out of the amount received from the Central/State Government for the specific purpose of dividend payment by the company in pursuance of a guarantee given by that Government.
2) Appropriate percentage of a company’s divisible profits for that financial year needs to be transferred to the company’s reserves before any provisions for dividends is declared for that financial year.
3) A company can declare and pay dividends only from its free reserves (and not from other specific reserves)
4) If during a particular financial year, a company’s profits are inadequate or if there is no profit, even then the company may declare a dividend out of the accumulated profits made by it in previous years, which was earlier transferred to the company’s reserves and lying there as free reserves. However, such a proposal of the company to declare a dividend is subject to compliance with various provisions of the Companies (declaration and payment of dividends) Rules, 2014.
Essential conditions to be fulfilled by a company desirous of divisible profit or declaring a dividend, despite its profits being inadequate or there being no profits during that financial year, are as follows:
i) The dividend rate should not be more than the average rate of dividends declared/paid by the company during the immediate three preceding financial years. However, this sub-rule is not applicable in the case of a company not declaring any dividend in each of the immediate three preceding financial years.
ii) The total amount to be withdrawn from the accumulated profits of the previous years for being used as dividend payment should not be more than 1/10 of the company’s ‘paid up capital + free reserves,” as disclosed by the latest audited financial statement.
iii) The amount taken from the accumulated profits should first be used to offset the losses curred during the financial year in which the dividend payment is proposed. Only after that, based on the remaining amount, should the dividend be declared/pard:
iv) After the withdrawal from the reserves, the balance amount lying in the reserves should not be less than 15% of the company’s paid-up share capital as disclosed by its latest audited financial statement, and v) A company cannot declare a dividend, unless the losses and depreciation, etc. carried over from the previous years (for which no provision was made during the respective years) are set-off against the distributed profits of the company during the financial year, during which the dividend is proposed to be declared.
v) The Board of Directors of a company are empowered to declare divisible profit or dividend during any financial year out of the:
- A cumulative surplus in the profit and loss account
- Profits of the company during the financial year in which such interim dividend is proposed to be declared/paid.
6) However, the declaration of such interim dividend is subject to certain conditions. If the company has incurred losses during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, the rate of such interim dividend should not be more than the rate of average dividend declared by the company during the preceding three financial years;
7) The amount of dividend (including the amount of interim dividend) is required to be deposited in a separate account with a scheduled bank within five days from the date of its declaration:
8) Dividends are payable by a company only to its registered shareholders, their order, or to their banker in cash. However, there are certain exceptions to the above rule, as indicated in the following points:
- Capitalization of profits or reserves of a company for issuing entirely paid-up bonus shares or paying up an amount, for the time being, unpaid on any share held by the company’s members.
- Any amount payable in cash may be paid by cheque/warrant or any other electronic mode to the shareholders.
9) If a company has not complied with the provisions of sections 73 and 74 of the Companies Act, 2013, it cannot declare any dividend on its equity shares as long as the violation of the above sections of the Act continues.
Salient Features to Dividend on Preference Shares
The salient features of the dividend payable to the preference shareholders are as follows:
1) Preference shareholders get priority over the equity shareholders as far as the dividend payment is concerned. They have a right to receive a dividend at a fixed rate before declaring dividends to equity shareholders.
2) Such right of the preference shareholders as mentioned above is, however, not absolute; it is subject to
- Generation of profits
- Recommendations of the Board of Directors (BoD) for making such dividend payments to the preference shareholders.
Provision for Dividend on Partly Paid Shares
Payment of dividends on partly paid shares is subject to different treatment if there is a provision to the effect in the Articles of Association of a company.
Other side is, there is no provision in a company’s Articles of Association. Both cases have been discussed in the following points:
1) If There is Requisite Provision in the Company’s Articles of Association:
i) Depending upon the provisions contained in the Articles of Association of a company, the dividend is payable on the amount of the following categories:
- Nominal shares
- Called-up shares
- Paid-up shares
ii) If a company is duly authorized by its Articles of Association, it may declare and pay dividends. Still, such payment should be proportional to the amount paid on each share. If a larger amount is paid on some shares than others, the dividend payment would be proportionate (section 51 of the Companies Act, 2013).
If There is No Provision in the Company’s Articles of Association:
i) In the absence of necessary provisions in the Articles of Association of a company, the dividend amount would be computed on the actual amount paid on shares. And while doing this exercise, the date of payment of such an amount also needs to be taken into consideration.
ii) Calculating the amount to be paid as a dividend is required to be carried out on the nominal amount of the shares.
iii) Dividends are declared and paid on shares by the amounts paid/credited for such shares. However, if no amount is found to have been paid/credited in respect of any or some of the shares, a dividend may be declared and paid according to the nominal amount of the shares.
iv) In the event of a new issue of share capital, the holders of such shares are eligible to receive dividends on a ‘paripassu’ basis with the existing shareholders, unless and until the terms of such fresh issue contain a clause precluding those shareholders.
Provisions for Dividends and Reserves
Various provisions of the Companies Act 2013 about dividends and reserves or divisible profit are as follows:
1) A company can declare a dividend in its general meeting. However, it should not be more than the amount as per the recommendations of the Board;
2) The Board of a company may decide, from time to time, to make payment of interim dividends to the members as deemed appropriate, keeping in view the company’s profits:
3) Before recommending any dividend, the Board may set aside an amount as reserve or reserves (out of the company’s profits) as considered justified. Creation and application of such reserves or reserves is the prerogative of the Board. It (the reserve or reserves) may be used for a purpose as deemed fit by the Board and is inclusive of the following:
- Creating provisions to meet any contingency
- For equalizing dividends
- Powing back into the business of the company
- For investing in such instruments (but not in the shares of that company) as decided by the Board from time to time.
4) The Board is also empowered to carry forward any profit or part thereof that is not considered to be divided (instead of setting aside as reserves).
Appropriation items in Appropriation Account of Profit and Loss Statement
Appropriation items appear in the appropriation account of a profit and loss statement, such as the amount transferred to general reserves or statutory reserves, proposed dividends, divisible profit, etc. The remaining items are shown on the liability side of the balance sheet. Important heads of appropriation items are discussed below:
1. Proposed Dividend
The amount of the proposed dividend appears on the liability side of a company’s balance sheet. It is recommended by a company’s Board of Directors (BoD) in a particular financial year. It is finalized after the expiry of that financial year but before the final preparation of the company’s financial statement for that financial year.
2. Dividend Distribution Tax (DDT)
1) Dividend distribution to the shareholders on the shares they hold is a part of ‘the appropriation of profits, which does not appear in the statement of profit and loss (ef. revised schedule III to the Companies Act, 2013). Appropriation of profits is shown in the ‘notes to accounts of the ‘reserves and surplus item on the liabilities side of the balance sheet.
2) The Dividend Distribution Tax (DDT) is levied on the dividend distributed only. As the payment of DDT is linked to the dividend distribution, no DDT would be payable if no dividend is declared/distributed.
3) As a logical sequel, DDT cannot be a part of the standard Income Tax provisions of a particular year: the former liability (DDT) arises only if part of the net profits is distributed as a dividend and not otherwise, whereas the latter liability (provision for the income tax) arises on the earnings of the taxable profit.
4) Therefore, liability on account of DDT is disclosed as appropriation allocation of the net profits in the ‘Notes to Accounts’ of ‘Reserves and Surplus,’ along with that of Distribution of Profits as Dividend”.
5) The manner of disclosure discussed above would present an accurate and transparent image of all the transactions about the dividend distribution and DDT.
6) It is necessary that DDT is recognized and disclosed in the accounts of the same financial year in which dividend distribution is recognized/ disclosed.
7) The amount of dividend distributed and DDT liability needs to be shown separately as mentioned in the ‘Notes to Accounts of ‘Reserves and Surplus’.
8) However, any provision created for DDT must be shown separately under the head’ Short-term Provisions in the balance sheet.