LEGAL CONSIDERATIONS IN DIVIDEND POLICY- AN OVERVIEW
While designing a dividend policy for a firm the legal and statutory framework should also be considered as the dividend policy is often constrained by legal and contractual factors. For public and private companies, the companies (Amendment) Act 1985 defines distributable profit as "Accumulated retained profits, so far as not previously utilized by distribution or capitalization, less accumulated realized losses, so far as not previously written off in a reduction or reorganization of capital duly made".
In India, several restrictions have been imposed on companies in respect of dividend payment. These provisions regarding quantum and procedure for payment of dividend are contained in section 205, 205A, 206, 206A and 207 of the Companies Act, 1956. These provisions may be summarized as follows:
- A Company can pay dividends to shareholders only if sufficient provision has been made for the redemption of preference shares, if any and also that sufficient depreciation has been provided as per Schedule XIII annexed to the Companies Act, 1956.
- All dividends must be paid in cash (with exception of scrip dividends i.e. bonus shares which is the capitalization of profits) the cash dividend may be paid either as
a) Final dividend which is payable after recommendation of the board of directors and approved by the shareholders at the annual general meeting of the company. There are certain procedural constraints and formalities in respect of payment of final dividend given in the bye-laws of the stock exchange where the shares are listed.
b) Interim dividend which is payable after passing a resolution by the Board of Directors and even before the finalization of accounts for that year. So, the interim dividend is paid in between two annual general meetings. The board may pay such dividend only if it expects sufficient profits for the period. The Companies Act, 1956 does not provide for payment of interim dividend and therefore, a company can pay interim dividend only if authorized by the Articles of Association of the Company. The Article 86 of the Table A also allows for the payment of the interim dividend.
Dividend is payable only out of current year revenue profits of the company. However, in certain cases, dividend can also be paid out of accumulated profits in case of inadequate or no current year profit. In this context, the following rules are worth noting:
The prescribed rules framed by the Central Government in this respect known as the Companies (Declaration of dividend out of reserves) Rules, 1975 Rule 2 provides that in the event of inadequacy or in the absence of profits in any year, dividend may be declared by it in the previous years and transferred by it to the reserves, subject to the conditions that:
a) The rate of dividend shall not exceed the average of the rate at which dividend was declared by it in the five years immediately preceding that year or 10 per cent of its paid up capital, whichever is less.
b) The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserve shall not exceed an amount equal to one-tenth of the sum of its paid up capital and free reserves and the amount so drawn shall first be utilized to set off the losses in the financial year before any dividend in respect of preference or equity shares is declared; and
c) The balance of reserves after such draw shall not fall below 15 per cent of its paid up capital
For the purposes of the rules, profit earned by a company in previous years and transferred by its to the ‘reserves' shall mean the total amount of net profits after tax, transferred to reserves as at the beginning of the year for which the dividend is to be declared; and in computing the said amount, the appropriation out of the amount transferred from the Development Rebate Reserve (at the expiry of the period specified under the Income Tax Act, 1961) shall be included and all items of capital reserves including reserves created by revaluation of assets shall be excluded.
Further that dividend is payable out of revenue profits only, however, in certain cases dividends can be paid out of capital profits also, subject to fulfillment of the following conditions:
a) Such capital profits are realized in cash.
b) The Articles of Association of the Company permits such payment.
c) Such capital profits exist after revaluation of other assets.
The payment of dividend out of capital profits is not very common in India. Glaxo (India) ltd, sold a part of its undertaking and out of the realized capital profit from such sale, it paid a Special Dividend @175% during 1994. Laking ltd. Also declared a Special Dividend of 600% in 1998 out of the profits resulting from the sale of undertaking to the Hindustan Lever Ltd.
Further, at the time of payment of dividend out of current year revenue profits, the company has to take care of the relevant rules as given in the Companies Act, 1956 as follows:
Sections 205 (2A) of the Companies Act, 1956 provides that before declaration and payment of dividend out of current year's profit, a company is required to transfer such percentage of its profits for the current year to reserves, not exceeding 10 percent, as may be prescribed. The Central Government has prescribed such percentage by framing the Companies (Transfer of profits to Reserves) Rules 1975. Rule 2 provides that no dividend shall be declared or paid by a company for any financial year out of its profits for that year arrived at after providing for depreciation in accordance with the provisions of sub section (2) of Section 205 of the Act except after the transfer to reserves of the company of a percentage of its profits for that year as specified below:(2005-06)
When the dividend proposed Amount to be transferred to the reserves not less than
- Exceed 10% but not 12.5% of the 2.5% of the current year profits
Paid up Capital
- Exceed 12.5% but not 15% of the 5% of the current year profits
Paid up Capital
Exceed 15% but not 20% of the 7.5% of the current year profits
Paid up Capital
Exceeds 20% of the paid up 10% of the current year profits.
Capital
It is evident that percentage of profit required to be transferred to reserves are linked to the rates of dividends. Thus, where the proposed dividend is exactly 10% or less of the paid up capital of the company, it is not obligatory to transfer any portion of the profits to the reserves. The dividends, once declared at the annual general meeting of the company must be paid within 42 days of the declaration. If not, then within 7 days from the date of expiry of the said period of 42 days, the company must deposit the unpaid dividends to a separate bank account to be opened by the company in a Scheduled Bank, to be called "Unpaid Dividend Account". If the money remains unpaid / unclaimed in this account for a period of three years from the date of transfer, then the company shall transfer such money to the General Revenue Account of the Central Government.
The most widely used method of distribution of earnings among the shareholders is to distribute by way of cash dividends. However, there is a number of other also of dividend payments. More common of these methods are the issue of bonus shares.
Dr.R.SRINIVASAN is a Post graduate in commerce and Management. He received his doctoral degree from Alagappa University in 1997. He is now Working as an ASSOCIATE PROFESSORin Post graduate and Research Department of Corporate Secretaryship at Bharathidasan Government College for Women (Autonomous), Pondicherry University, Puducherry.He currently teaches Accounting , financial management and Research Methodology Subjects. Before Joining BGCW, he was teaching in SNR College, Coimbatore, Sindhi college, Chennai& T.S.Narayanasamy College, Chennai for eight years. He was with the industry for a short term at Salzar Electronics Pvt. Ltd, Coimbatore. He has about 20 years of teaching experience and having research experience of 15 years. His interests are in Accounting and finance, Capital Market, Quantitative Methods. He underwent the Faculty Development Programme at Indian Institute of Management Ahmedabad during 2000-01. He has presented 20 papers in national and international conferences and has published twenty papers in the areas of Finance and Human resource Management in National Journals. Co-authored a book titled, ‘Investors Protection, published by Raj Publications, New Delhi He has delivered lectures in contemporary finance topics at Pondicherry University. He is involved in consultancy projects for Godrej Saralee, Chennai in the areas of Statistical Applications. He has supervised a number of research projects in the area of corporate finance and Human Resource Management. He is the Board of examiner in corporate Secretaryship and Management for the past two decades.
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Article Source: ArticlesBase.com
