Rules Regarding Dividend
The Companies Act provides various rules regarding the declaration and payment of dividend. They are summarized below:
1. Right to Recommend the Dividend
The right to recommend a dividend lies with the Board of directors. Only when the Board recommends a dividend, the shareholders can declare a dividend in the general meeting. However, the shareholders cannot insist the directors to recommend. Even if there are sufficient profits, but the directors feel that a distribution of dividend is undesirable in the interests of the financial stability of the company, they can refuse to recommend a dividend.
2. Right to Declare a Dividend
Only the shareholders in the Annual General Meeting can declare the dividend. The Board of Directors determines the rate of dividend to be declared and recommends it to the shareholders. The shareholders, by passing a resolution in the general meeting, can declare the dividend. The shareholders can either accept the same rate of dividend or they can even reduce the rate. However, they cannot enhance the rate of dividend recommended by the directors.
3. Payable out of Profits Only
The company can declare and pay a dividend only where there is a profit. In other words, dividend is payable only out of profits. If there is no profit, there can be no distribution of dividend. The Companies Act provides that a dividend can be paid only:
1. Out of the profits of the Current financial year, or
2. Out of the profits of the previous years, or
3. Out of moneys provided by the Central or State Governments for the purpose of paying a dividend.
Therefore, if a dividend is paid out of capital, it amounts to a breach of trust. It amounts to an unauthorized reduction of capital and is ultra vires. Hence, void. The directors shall become jointly and severally liable.
4. Provision for Depreciation
It is already stated that a dividend can be declared only out of profits. The profits should be arrived only after providing for depreciation for the current year and also for all the arrears of depreciation or loss in any previous year [Sec. 205 of Companies Act]. However, the Central Government can exempt any company from this obligation in the interest of the public.
5. Setting off the Previous Losses
If any loss is incurred in any previous year after 1960, such loss should be set off against the profits of the current year before declaring a dividend [Sec. 205(1)(b)].
6. Payable Only in Cash
The dividend is payable only in cash. However, a company is not prohibited from capitalizing its profits or reserves by the issue of bonus shares or by making partly paid up shares into fully paid up shares.
7. Transfer to Reserves
It is also provided in the Companies Act that every company before declaring any dividend should transfer a certain percentage not exceeding 10% of the profit, to the reserves of the company. The percentage shall be prescribed by the Central Government.
Separate rates are prescribed if the company declares the dividend out of the current year’s profits. The Table below shows the percentages of profits to be transferred compulsorily to reserves before declaration of any dividend as per the provision of the Companies (Transfer of Profits to Reserves) Rules, 1975.
TABLE: Percentage of Profits transferred to Reserves before declaring Dividend
However, the companies are at liberty to transfer a higher percentage of profit to the reserves. The Companies Amendment Act introduced this provision only in the year 1974 by incorporating Sec. 205 A in it.
8. Time Limit for Payment
When a dividend is declared, it should be paid within 42 days from the date of declaration. The dividend when declared shall become a debt due from the company. If the company does not pay the dividend within the period, every person who is a party to the default is punishable with simple imprisonment up to seven days and also with a fine.
9. Unpaid Dividend Account
If a dividend is declared but not paid within 7 days from the date of expiry of the 42 days, should transfer the amount of unpaid dividend to a separate account with any Scheduled Bank opened under the style “Unpaid Dividend Account of………Company Ltd“.
10. Transfer to General Revenue Account
Any amount transferred to the Unpaid Dividend Account, which remains unpaid or unclaimed for a period of three years, should be transferred by the company to the General Reserve Account of the Central Government. However, the person to whom the dividend is payable can claim the money from the Central Government. The company which transfers any amount to the General Reserve Account, should furnish a statement furnishing the nature of amount, names of the persons entitled to receive the amount, their addresses, amount due to them, etc.