Section 123 (3) and also section 123 (4) contain provisions regarding interim dividend. Following points are noteworthy:
Interim dividend may be declared by the Board of Directors at any time during the period from closure of financial year till holding of the annual general meeting.
Declaration of interim dividend shall be ratified at the ensuing AGM by the members.
II. Classification based on Nature of Shares does not require any specific provision in the articles.
|BASIS FOR COMPARISON||INTERIM DIVIDEND||FINAL DIVIDEND|
|Definition||Interim dividend is declared and paid during an accounting year, i.e. before the finalisation of accounts for the year.||Final dividend is the dividend recommended by the board of directors, and approved by shareholders at the company's Annual General Meeting, after the cloase of financial year.|
|Announcement||Announced by board of directors.||Recommended by board of directors and approved by shareholders.|
|Time of declaration||Before preparation of financial satements.||After preparation of financial statements.|
|Revocation||It can be revoked with the consent of shareholders.||It cannot be revoked.|
|Provision in Articles of Assocition||It is declared only when the articles specifically permits the declaration.||It does not require any specific provision in the articles.|
Shares can be classified into two categories i.e. preference shares and equity shares. The manner of payment of dividend is dependent upon the nature of shares.
(i) Preference Shares: According to Section 43 of the Companies Act, 2013, shareholders holding preference shares are assured of a preferential dividend at a fixed rate during the life of the company.
Preference dividend unless otherwise agreed is Non-cumulative in nature and need not be paid in any year where there is deficiency of profits.
Classification of preference shares on the basis of payment of dividend is as follows:
- Cumulative Preference Shares: A cumulative preference share is one in respect of which dividend gets accumulated and any arrears of such dividend arising due to insufficiency of profits during the current year is payable from the profits earned in the later years. Until and unless dividend on cumulative preference shares is paid in full, including arrears, if any, no dividend is payable on equity shares.
- Non-cumulative Preference Shares: A non-cumulative preference share is one where the dividend is payable only in a year of profit. There is no accumulation of profit as in the case of cumulative preference shares. In case no dividend is declared in a year due to any reason, the right to receive such dividend for that year expires and the holder of such a share is not entitled to be paid arrears of dividend out of future year’s .
(ii) Equity Shares: Equity shares are those shares, which are not preference shares. It means that they do not enjoy any preferential rights in the matter of payment of dividend or repayment of capital. The rate of dividend on equity shares is recommended by the Board of Directors and may vary from year to year. Rate of dividend depends upon the dividend policy and the availability of profits after satisfying the rights of preference shareholders.
3. PROVISIONS REGARDING DECLARATION AND PAYMENT OF DIVIDEND
A. Sources for Declaration of Dividend
According to Section 123 (1), the dividend for any financial year shall be declared or paid from the following sources:
- Profits of the current financial year- Profits arrived at after providing for depreciation in accordance with Schedule II.
- Profits of any previous financial year or years- Profits of any previous financial year(s) arrived at after providing for depreciation in accordance with Schedule II and remaining undistributed i.e. credit balance in profit and loss account and free reserves. It is to be noted that only free reserves and no other reserves are to be used for declaration or payment of dividend.
- Both (a) and (b).
- Provision of money by the Government- Money provided by the Central Government or a State Government for the payment of dividend by the company in pursuance of a guarantee given by that Government.
Note 1: Before declaration of any dividend, carried over previous losses and depreciation not provided in previous year or years are required to be set off against profit of the company for the current year.
Note 2: In computing profits any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value shall be excluded.
Note 3: Capital profits are not same as distributable profits because they are not earned in the normal course of business; and therefore, normally not available for distribution as dividend.
Need for providing for depreciation out of profits before declaring dividend
Dividend is an apportionment from revenue profits. Therefore dividend should never be declared out of capital. This is also the reason for prohibition on issue of shares at a discount which you studied in the topic Share Capital and Debentures.
"Depreciation" is a notional estimate of the reduction in the value of an asset due to
i. wear and tear,
ii. efflux of time,
iii. improvements in technology etc.
If depreciation is not provided for there will be two consequences:
i. The value of the asset will be overstated in Balance Sheet
ii. The profits of the current year will be overstated.
Let us take an hypothetical case where a company declares all the profits earned during any year as dividend.
At the time of winding up of the company the value of assets appearing in the Balance-sheet would appear to be sufficient to repay the capital of the shareholders but the actual realizable value thereof will be a paltry sum which may not be sufficient even to meet the expenses of winding up.
This is because the company has failed to retain the amount of wear and tear in the value of the asset by way of provision for depreciation. In a way the company would have declared dividend out of capital, which is prohibited.
Hence the law mandates provision for depreciation out of profits before declaration of dividend.
Example 4: Shreyas Mechanics Limited owns a plot of land which was purchased long before. As the property rates are going up, it is decided to revalue the plot at fair value which is moderately ten times the original price, thus resulting in a revaluation profit of ` 20,00,000. The Board of Directors is keen to utilize this ` 20,00,000 along with free reserves of 24,00,000 for declaration of dividend at the forthcoming Annual General Meeting (AGM) to be held on 28th September, 2019. But according to Proviso to Section 123 (1) (a), the amount of 20,00,000 cannot be considered as it does not form part of Free Reserves as the same cannot be utilized towards declaration of dividend.
B. Transfer to Reserves
Transfer of profits to reserves for any financial year has been left to the discretion of the company. Therefore, a company is free to transfer any portion of its profit to reserves as it may deem fit. It may also decide not to transfer any amount to reserves.
Example 5: For the current year, Alma Watches Limited proposes to transfer more than 10% of its profits to the reserves before declaration of dividend at the rate of 12%. Can the company do so?
Answer: The amount to be transferred to reserves out of profits for any financial year before the declaration of dividend has been left to the discretion of the company. Therefore, Alma Watches Limited is free to transfer any part of its profits to reserves as it may deem fit.
Example 6: Brix Shipyards Limited has earned a profit of ` 1,000 crores for the financial year 2018-19. It has proposed a dividend @ 8.75%. However, it does not intend to transfer any amount to the reserves out of the profits earned. Can the company do so?
Answer: The amount to be transferred to reserves out of profits for any financial year has been left to the discretion of the company. The company is free to transfer any part of its profits to reserves as it may deem fit or it may even not transfer any profits to reserve if it is deemed appropriate before the declaration of dividend. Thus, Brix Shipyards Limited is justified in its action if it does not transfer any amount of profits to the reserves.
C. Declaration of Dividend when there is inadequacy or Absence of Profits (Second Proviso to Sec. 123)
Where in any year there are no adequate profits for declaring dividend, the company may declare dividend out of the profits of any previous year transferred by it to the free reserves only in accordance with the procedure laid down in Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014.
Free Reserves 8means such reserves which, as per the latest audited balance sheet of a company, are available for distribution as dividend:
The following shall not be treated as free reserves;
Any amount representing unrealized gains, notional gains or revaluation of assets, whether shown as a reserve or otherwise, or
Any change in carrying amount of an asset or of a liability recognized in equity, including surplus in profit and loss account on measurement of the asset or the liability at fair value.
Under Rule 3 such declaration shall be subject to the following conditions:
The rate of dividend declared shall not exceed the average of the rates at which dividend was declared by the company in the immediately preceding three years.
However, this condition shall not apply if the company has not declared any
dividend in each of the three preceding financial year.
The total amount to be drawn from such accumulated profits shall not exceed 10% of its paid-up share capital and free reserves as appearing in the latest audited financial statement. In other words:
Total amount that can be drawn from accumulated profits ≤ 10% of (paid up share capital + free reserves)
The amount so drawn shall first be utilised to set off the losses incurred in the financial year in which dividend is declared and only thereafter, any dividend in respect of equity shares shall be declared.
The balance of reserves after such withdrawal shall not fall below 15% of its paid up share capital as appearing in the latest audited financial statement.
Free Reserves – Amount drawn for payment of dividend >= 15 % of paid up share capital
It may be noted that all the above three conditions have to be satisfied.
The conditions prescribed by Rule 3 are not applicable to a Government company in which the entire paid up share capital is held by the Central Government, or by any Stale Government or Governments or by the Central Government and one or more State Governments (vide Notification No. 463 (E), dated 05-06-2015).
Example 7: Capricorn Industries Limited has a paid-up capital of 200 lakhs and accumulated Reserves of 240 lakhs. Loss for the year ending 31st March 2020 is 30 Lakhs. Dividend was immediately preceding. declared at the following rates during the three years
Year 1 = 9%
Year 2 = 10%
Year 3 = 12%
What is the maximum rate at which the company can declare dividend for the current year.
Answer: In the given case, Capricorn Industries Limited has not made adequate profits during the current year ending on 31st March, 2020, but it still wants to declare dividend. Let us apply the conditions:
Average Rate = (9+10+12)/3 = 10.3%
Therefore, the rate of dividend shall not exceed 10.3%.
i.e. 10.3% of Paid up Capital
Paid-up capital + Free reserves (Assuming all reserves are free) =(200+240) Lakhs = 440 Lakhs
10% thereof = 44 Lakhs
Less: loss for the year = 30 Lakhs
Amount available = 14 Lakhs
Hence the quantum of dividend is further restricted to = 14 lakhs.
Accumulated Reserves = 240 Lakhs
Proposed withdrawal declaration of dividend = 14 Lakhs
Balance of Reserves = 226 Lakhs
This is more than 15% of paid-up capital (i.e 15% of 200 Lakhs) i.e. 30 lakhs.
Thus, the company can declare a dividend of 14 lakhs i.e. at a rate of 7% on its paid-up capital of 200 lakhs.
Example 8: Shipra Sugar Mills Limited has been regularly declaring dividend at the rate of 20% on its equity shares for the past 3 years. However, the company has not made adequate profits during the current year ending on 31st March, 2020, but it has got adequate free reserves which can be utilized for maintaining the rate of dividend at 20%.
Advise the company as to how it should proceed in the matter if it wants to declare dividend at the rate of 20% for the year 2019-20, as per the provisions of the Companies Act, 2013.
Answer: The company can declare a dividend out of its Accumulated Free Reserves subject to satisfaction of the following conditions:
- The total amount to be drawn from free reserves shall not exceed 10% of its paid-up share capital and free reserves as per the latest audited financial statement.
- The amount so drawn shall first be utilised to set off the losses incurred in the current financial year and only thereafter, dividend at 20% shall be declared.
- After such withdrawal from free reserves, the residual reserves shall not fall below 15% of its paid-up share capital as per the latest audited financial statement.
The company is advised to get the desired dividend recommended by the Board of Directors and propose the same for the approval of the members at the ensuing Annual General Meeting as the authority to declare dividend lies with the members of the company.
D. Depositing of Amount of Dividend
In terms of section 123(4), the amount of the dividend (including interim dividend), shall be deposited in a separate account maintained with a scheduled bank. This is to be done within 5 days from the date of declaration of dividend.
Example 9: The authorised and paid-up share capital of Avantika Ayurvedic Products Limited is 50.00 lacs divided into 5,00,000 equity shares of 10 each. At its Annual General Meeting (AGM) held on 24th September, 2019, the company declared a dividend of 2 per share by passing an ordinary resolution. The amount of dividend must be deposited in a scheduled bank in a separate account latest by 29th September, 2019.
E. Payment of Dividend
Section 123(5) contains provisions regarding payment of dividend. These are stated as under:
- Dividend shall be payable only to the registered shareholder or to his order or to his banker.
In case a shareholder informs the company to pay dividend to a particular banker and if the payment is so made by the company, then it shall be deemed to be made to the shareholder himself.
A purchaser of shares whose name is not entered in the Register of Members cannot claim payment of dividend to him though he might have made full payment to the seller of shares. In this regard we will, later in this chapter, see Section 126 which provides for keeping of dividend etc., in abeyance pending registration of transfer of shares, unless the registered holder has authorized the company to pay the dividend to the purchaser.
Example 10: The Directors of East West Limited proposed dividend at 15% on equity shares for the financial year 2018-2019. The same was approved in the Annual general body meeting held on 24th October 2019. The Directors declared the approved dividends. Mr. Binoy was the holder of 2000 equity of shares on 31st March, 2019, but he transferred the shares to Mr. Mohan, whose name has been registered on 18th June, 2019. Who will be entitled to the above dividend ?
Answer: Dividend shall be payable only to the registered shareholder or to his order or banker. In this case Mr. Binoy is the registered shareholder and therefore it shall be sufficient compliance with the law if the company pays the dividend to Mr. Binoy.
Example 11: The Board of Directors of Som Mechanical Toys Limited proposed a dividend at 12% on equity shares for the financial year 2019-20. The same was approved at the Annual General Meeting of the company held on 25th June, 2020.
Mr. Nitin Jha was holding 1,000 equity shares as on 31st March, 2020, but the same were transferred by him to Mr. Raj, whose name was registered on 20th April, 2020 in the Register of Members. State as to who will be entitled to the dividend declared by the company.
Answer: According to section 123(5), dividend shall be payable only to the registered shareholder of the shares or to his order or to his banker. Facts in the given case state that Mr. Nitin Jha, the holder of equity shares transferred his shares to Mr. Raj whose name was registered on 20th April, 2020. Since, Mr. Raj became the registered shareholder before the declaration of the dividend in the Annual General Meeting of the company held on 25th June, 2020, he will be entitled to the dividend.
Note: In terms of Section 51, a company may, if so authorised by its articles, pay dividend in proportion to the amount paid-up on each share. Suppose, some of the shareholders have paid only ` 5 (face value ` 10) on each share held by them. In case of declaration of dividend at the rate of ` 5 per share, the company, if authorised by its articles, shall be justified in paying dividend of ` 2.50 per share in respect of such partly paid shares.
- Dividends are payable in cash and not in kind. Dividends that are payable to the shareholders in cash may also be paid by cheque or dividend warrant or through any electronic mode.
Section 127 requires that the declared dividend must be paid to the entitled shareholders within the prescribed time limit of thirty days from the date of declaration of dividend. In case dividend is paid by issuing dividend warrants, such warrants must be posted at the registered addresses within the prescribed time. Once posted, it is immaterial whether the same are received within thirty days by the shareholders or not.
Note: Dividends shall be paid only in cash. The exception to this is the capitalization of profits or reserves of a company 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.
But you may note that while Declaration of dividend does not affect the company’s power to issue fully paid up bonus shares, such shares cannot be issued in lieu of dividend.
- Applicability of Section 123 (5) to Nidhis: In terms of Notification No. GSR 465 (E), dated 05-06-2015, this sub-section shall apply to the Nidhis, subject to the modification that any dividend payable in cash may be paid by crediting the same to the account of the member, if the dividend is not claimed within 30 days from the date of declaration of the dividend.