VIP Road Chartered Accountants Association

Law relating to dividends - Recent developments

Dividend is the return that a shareholder gets from a company out of its profits, on his shareholding. The Companies Act has been amended by the Companies (Amendment) Act, 1999 and the Companies (Amendment) Act, 2000. The Government has permitted the issue of shares with differential rights. Dividend can be now paid through Electronic Clearing Services (ECS) by the banks. Foreign Exchange Management Act (FEMA), 1999 has been enacted to replace Foreign Exchange Regulation Act, 1973. Many investors hold shares in a electronic mode. On account of all these changes, a re-look at various aspects of the law relating to dividend has become necessary. In this comprehensive article, on the subject of dividend, the author goes through the entire gamut of the payment/distribution of dividend, including the aspect of tax deduction at source - Editor What is dividend The term ‘dividend’ refers to that part of the profits of a company which is distributed amongst its shareholders. It may, therefore, be defined as the return that a shareholder gets from the company, out of its profits, on his shareholding. According to the Institute of Chartered Accountants of India, dividend is a distribution to shareholders out of profits or reserves available for this purpose - See the Guidance Note on Terms used in Financial Statements. Definition of ‘dividend’ According to section 2(14A) of the Companies Act, 1956, the term ‘dividend’ includes any interim dividend. It is an inclusive and not an exhaustive definition. According to the generally accepted definition, ‘dividend’ means the profit of a company, which is not retained in the business and is distributed among the shareholders in proportion to the amount paid up on the shares held by them. The Supreme Court in CIT v. Giridharidas & Co. (P.) Ltd. AIR 1967 SC 795 has defined the term ‘dividend’ in the following manner : (i) As applied to a company which is a going concern, it ordinarily means the portion of the profits of the company, which is allocated to the holders of shares in the company. (ii) In the case of winding up, it means a division of the net realised assets among creditors and contributories according to their respective rights.Payment of dividend Every company (other than section 25 company) has an implied power to pay dividend to its members. However, the power to pay dividend is subject to the following two fundamental rules:
(1) Dividend must not be paid out of capital.
(2) Dividend should be paid out of profits. Company law provisions regarding dividend Section 205 of the Act provides as under :
No dividend shall be declared or paid by a company for any financial year except :(1) Out of the profits for that year arrived at after providing for depreciation in accordance with sub-section (2) ; or
(2) Out of the profits of the company for any previous year or years arrived at after providing depreciation in the prescribed manner and remaining undistributed or out of both;
(3) Out of (a) and (b) above ;
(4) Out of moneys provided by the Central or State Government for this purpose in pursuance of a guarantee given by that Government. Arrears of depreciation If the company has not provided for depreciation for any previous financial year or years, it shall, before declaring or paying dividend for any financial year, provide for such depreciation out of the profits of that year or any other previous year. Past losses to be set off If the company has suffered any loss in any financial year after December 28, 1960, then the amount of loss or the amount of depreciation, whichever is less, shall be set off against the profits of the company for that year for which dividend is declared or against the profits for any financial year or years. Transfer to reserve Before declaring any dividend, every company is required to transfer a percentage, not exceeding 10 per cent of the current profit to the reserves of the company as prescribed by the Companies (Transfer of Profits to Reserves) Rules, 1975. The percentage of profits required to be transferred to reserves is linked to the rate of dividend proposed for the year and is given hereunder:
Rate of dividend % of profit required to be
transferred to reserves
Up to 10% Nil
Exceeding 10% but not exceeding 12.5% not less than 2.5% of the current profits
Exceeding 12.5% but not not less than 5% of the current
exceeding 15% profits
Exceeding 15% but not not less than 7.5% of the current
exceeding 20% profits
Exceeding 20% not less than 10% of the current profits. The rules, however, do not prohibit the voluntary transfer by a company of a percentage higher than 10 per cent of its current profits to reserves for any financial year subject to certain conditions. Under rule 3, voluntary transfer by a company of a percentage higher than 10 per cent of its profits to reserves is allowed, provided that: (a) where a dividend is declared by a company in that financial year, a minimum distribution sufficient to maintain a rate of dividend equal to the average rates of dividend declared by it over the three years immediately preceding the financial year is ensured; (b) where bonus shares have been issued in the year in which the dividend is declared or in the three years immediately preceding the financial year, a company can transfer a higher percentage of profits to reserves, provided a minimum distribution of dividend to shareholders of an amount equal to the average amount (quantum) of dividend declared over the three years immediately preceding the financial year is maintained. However, maintenance of such minimum rate or quantum of dividend is not necessary if the net profits after tax in a financial year are lower by 20 per cent or more than the average profits after tax of the two immediately preceding financial years. Where no dividend is declared, the amount proposed to be transferred to its reserves from the current profits shall be lower than the average amount of the dividends to the shareholders declared by it over the three years immediately preceding the financial year. [The term ‘reserves’ referred to in the said rules means only free reserves]. A newly incorporated company is prohibited from transferring more than 10 per cent of its profits to its reserve - Circular No. 20/76(5)/10/76-CL-XIV and 1/1/76-CL-VI, dated July 26, 1976 issued by the Department of Company Affairs. Current profits The term ‘current profits’ for the purpose of transfer of specified percentage thereof to reserve means profits after statutory transfer to the Development Rebate Reserve and also after providing for arrears of depreciation, if any. The term ‘dividend’ referred to in the above-mentioned Rules is the dividend on equity shares and dividend payable on participating preference shares over and above the fixed rate of dividend on such preference shares. - Clarification issued by the Department of Company Affairs - Circular No. 8/76 (1/1/76-CL.V), dated May 18, 1976 read with 12/76 (1/1/-76-CL.V), dated June 10, 1976. Compliance with section 80A Section 80A of the Act provides that if a company has issued irredeemable preference shares, they must be redeemed within 5 years from June 15, 1988. Preference shares which are redeemable after 10 years should be redeemed as they fall due, but the period of redemption should not exceed 10 years. If a company is unable to redeem the preference shares as aforesaid, it should make a petition to the Company Law Board (CLB), which may permit their renewal under a 10 year scheme and then they shall be deemed to have been redeemed. If a company fails to comply with the provisions of section 80A, it shall not, so long as the failure continues, declare any dividend on its equity shares. Time limit for payment Where a dividend, whether interim or final, is declared, it should be deposited in a separate bank account within 5 days from the date of declaration. Dividend should be paid within 30 days from the date of declaration.Transfer to unpaid dividend account [Section 205A] The total amount of dividend remaining unpaid or unclaimed within 7 days from the date of expiry of 30 days from the date of declaration thereof should be transferred to a separate bank account called ‘Unpaid Dividend Account of . . . Company Ltd.’.
This requirement does not apply to the Government companies. The company should pay interest at the rate of 12 per cent per annum on any unpaid dividend amount, if the same is not transferred to the unclaimed dividend account within 37 days from the date of declaration of dividend. The interest so accruing shall be paid to the shareholders in proportion to the dividend amount remaining unpaid to them. Proportion in which dividend is payable Section 93 of the Act provides that a company may, if so authorised by its articles, pay dividend in proportion to the amount paid-up on each share where a larger amount is paid-up on some shares than on others. Companies which adopt the regulations contained in Table A of the Act can pay dividend in proportion to the amount paid-up on shares article 88 of Table A. However, if a company has excluded Table A and has its own articles, and its articles do not contain a regulation similar to article 88 of Table A, it has to pay dividend on the nominal amount of each share and not on the amount paid-up on the share - Oakbank Oil Co.’s case. Dividend on preference shares Preference shares are generally issued as cumulative, which means that the holders of such shares can claim the arrears of dividend on such shares. Arrears of dividend on preference shares can be paid only out of divisible profits. Preference shareholders are entitled to dividend before any dividend is paid on equity shares. Sometimes, preference shares are redeemed in the middle of the year. At the time of redemption, if the company has not declared dividend on preference shares, the company cannot pay dividend for the accounting year in which preference shares are redeemed. The dividend due at the time of redemption can be paid by the company only after the company declares dividend for the relevant year in its annual general meeting or the preference dividend due is declared by way of interim dividend.Sometimes preference shares are issued on non-cumulative basis. The non-cumulative preference shares give right to fixed percentage as dividend out of the profits of each year. If no profit is available in any year, the non-cumulative preference shareholders get nothing, nor can they claim unpaid fixed dividend in subsequent years.The preference shareholder cannot claim dividend as a matter of right, unless the dividend is declared by the company. Payment of dividend out of reserves Companies can declare dividend out of the accumulated profits earned in previous years and transferred to the reserves in case of inadequacy or absence of profits in any year in accordance with the Companies (Declaration of Dividends out of Reserves) Rules, 1975. The rules prescribe the following norms for declaration of dividend out of reserves, namely:(i) The rate of dividend is not to exceed the average of the rates of dividends declared in the preceding five years or 10% of the paid-up capital whichever is less. (ii) The amount drawn from the reserves shall not exceed one-tenth of the aggregate of its paid-up capital and free reserves. The amount so drawn is to be first utilized to set off the losses incurred in the financial year before any dividend is declared. (iii) The balance of reserves after such withdrawal shall not fall below 15% of its paid-up share capital. Payment of dividend from P & L account Since the conditions prescribed in the above-mentioned Rules are rigid, many companies follow the practice of keeping adequate surplus in the profit and loss account. Keeping such surplus in the profit and loss account will help the dividend to be paid at a higher rate permissible in the above-mentioned Rules as drawing the surplus from profit and loss account is not hit by these Rules. Declaration of dividend The Act does not specifically provide as to who should declare dividend. Section 217(1)(c) of the Act states that there shall be attached to every balance sheet laid before a company in general meeting a report by its board of directors, with respect to the amount, if any, which it recommends should be paid by way of dividend. This section indicates that the board of directors is entitled to determine and recommend to the general meeting, the rate and quantum of dividend to be declared by the shareholders. If the directors do not recommend any dividend, the general meeting has no power to declare dividend. Section 173(1)(a) of the Act states that declaration of dividend is a routine business at the annual general meeting. Regulation 85 of Table A states that the company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the board. So, the general meeting at which dividend is declared has no power to increase the rate of dividend. However, the general meeting can reduce the rate of dividend. Though the right to declare dividend is given to the general meeting, the real control over dividend vests with the board of directors. Dividend to be paid to registered shareholder The dividend shall be paid only to the registered shareholder or to his order or to his bankers, or, in case a share warrant has been issued, to the bearer of such share warrant or to his bankers. In the case of joint holders, the dividend should be paid to the first joint holder. Payment of dividend to non-resident shareholders In term of the FEMA (Current Account Transactions) Rules, 2000, read with AD (MA Series) Circular No. 11, dated, May 16, 2000, an authorised dealer is empowered to remit payment of dividend by Indian Companies to non-resident shareholders and for this purpose, the Authorised dealers are empowered to devise their own documentation complying with section 10(5) of FEMA, 1999. Premium on issue of securities cannot be distributed as dividend According to section 205, dividend can be paid only out of profits or out of moneys provided by the Government for the purpose. Premium on issue of securities cannot be distributed legally, as dividend because, according to section 78(2), it can be applied only for the following four purposes, namely:
(i) for issuing bonus shares;
(ii) for writing off the preliminary expenses of the company;
(iii) for writing off the expenses of or the commission paid or discount allowed on, any issue of shares or debentures of the company;
(iv) for providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company. Recent developmentsThe Department of Company Affairs has issued a notification stating that the payment of dividend to the shareholders involving the fraction of 50 paise and above be rounded off to the rupee and the fraction of less than 50 paise may be ignored - Notification No. GSR No. 598(E), dated July 28, 1994. Whenever a company issues dividend warrant, banks insist that the dividend warrants should be printed with MICR coding with a view to facilitating clearance of the dividend warrants in the RBI/Bankers’ clearing house. Before issuing dividend warrants, banks should get Reserve Bank’s clearance for the quality of paper used for printing dividend warrants and the quality of printing. This clearance is given by the National Clearing Cell in the Reserve Bank. The Budget for 2002-2003 has proposed that tax should be deducted at source on dividends paid as provided in section 194 of the Income-tax Act. In this connection, the Department of Company Affairs has issued general Circular No. 17 of 2002 vide F. No. 17/36/2002-CL-V, dated July 5, 2002. The Circular is reproduced below: “Section 205(3) of the Companies Act, 1956 (‘the Act’) provides for payment of dividend except in cash and section 205(5)(b) of the Act further provides that the dividend payable in cash may be paid either by cheque or warrant. Subsequent to the amendment to section 10(33) of the Income-tax Act, 1961, dividend would be taxable in the hands of the recipient in respect of dividend income and this would, in the opinion of the Department of Revenue, involve huge amount of paper work as persons responsible for paying the income would be required to deduct tax at source from the amount of dividend paid and issue of TDS certificate. The Department of Revenue in order to reduce the additional paper work involved in the above method had suggested that the dividend warrant or intimation sent to the shareholders by company may be modified to contain the TDS also. Accordingly, in consultation with the Department of Revenue, it is hereby, clarified that henceforth, companies may adopt a format for dividend warrants to include information on TDS as under:

Ledger folio No. of equity shares Warrant No Gross dividend (Rs) Rate of tax Tax deducted (Rs) Net amt. payable
(Rs)
Certified that a sum of Rs. (in words)..............has been deducted at source and paid to the credit of the Central Government.
Place........... ........................
Signature of person responsible
for deduction of tax
Date...........
Full Name..........
Designation........
The above format of TDS may be printed on the reverse side of the warrant duly signed by persons responsible for deduction of tax. You are requested to kindly bring to the notice of your constituents about the circular and request them to adopt the same. Wherever demat and transfer of dividend by electronic mode is used, the companies may, however, issue TDS in the same format. While dividend is paid by cash or cheque, companies may issue TDS certificate in the above format along with dividend intimation.”Equity shares with differential rights The Companies (Amendment) Act, 2000 has introduced a new type of equity shares which may carry differential rights as to voting, dividend, etc. Issue of such shares is governed by the Companies (Issue of Share Capital with Differential Rating Rights), Rules, 2001. It is now possible to issue equity shares carrying a higher rate of dividend, say 1 per cent or 2 per cent more than the dividend on ordinary equity shares. If such shares are issued by the company, the dividend payable on those shares should be separately calculated as per the terms of issue of such shares. Dividend on dematerialised shares Many companies have entered into agreement with National Securities Depository Ltd. (NSDL) and Central Depository Services (India) Ltd. (CDSL) for converting physical shares into dematerialised shares (that is, shares are converted into electronic form). The shares held in electronic form are transferred by the depository. Companies collect the list of members holding shares in the depository and pay them the dividend. Stock exchange requirements In case of listed companies, the following clauses of Listing Agreement have to be complied with. (i) At laest 42 days’ notice in advance of the closure of the Register of Members or Record Date is to be given to the Stock Exchanges where the company’s shares are listed. This notice should be sent to other recognised Stock Exchanges in India. [Clause 16 of the Listing Agreement] 30 days advance notice should be given to the Depositories if the company’s shares are dematerialised, about Closure of Register of Members.(ii) Date of Board Meeting at which dividend is declared/recommended is due to be considered [Clause (19) of Standard Listing Agreement] is to be notified 7 days in advance to Stock Exchange where the shares of the company are listed. (iii) The dividend will be recommended/declared at least 5 days before commencement of closure of Transfer books or record date fixed for the purpose [Clause (19) of Listing Agreement].(iv) The Stock Exchange on which shares are listed should be intimated immediately by letter, (telegram, fax, e-mail if the meeting is held outside the city) the Board meeting has been held to consider or decide the dividend to be declared (Clause 20 of Standard Listing Agreement), about all the dividend recommended or declared.(v) The Stock Exchange should be informed at least 21 days in advance of the date on and from which the dividend on shares shall be payable and issue simultaneously the dividend warrants which should be collectable at par with collection charges, if any, being borne by the company, in any bank in the country at the centres other than the centres agreed to between the company and the exchange [clause (21) of Standard Listing Agreement]. Revocation of declared dividend As stated earlier, a dividend including interim dividend once declared becomes a debt. So, it cannot be revoked, except with the consent of the shareholders. Dividend can be paid through Electronic Clearing Services (ECS)The shareholders have complained in the past about loss of dividend warrants sent by post due to pilferage in transit or undue delay in receipt of dividend warrants through post. According to section 205(5)(b), a company may remit dividend in cash or by cheque or by warrant. It is, however, well-known that the amount of dividend can also be transmitted electronically to shareholders after obtaining their consent in this regard and asking them to nominate a specific bank account number to which the dividend due to them should be remitted. The Central Vigilance Commission has issued an order dated November 27, 1998 directing that the banks may switch over to remittance of dividends by computerised means as it will help to improve the vigilance administration. The Central Vigilance Commissioner has also requested the Department of Company Affairs that in the interest of greater transparency, listed companies in India may be directed that they should go in for computerised cash transaction so far as payments of dividend, interest, refund, etc., are concerned. Consequently, the Department of Company Affairs, has recently advised listed companies to encourage their shareholders to send their authorisation to remit dividend to their designated bank account by means of electronic transfer as this will result in avoiding delay in remittance of dividend, etc., SEBI has also asked the listed companies to use Electronic Clearing Service facility for payment of dividend wherever such facility is available. [SEBI Circular DCC/FITT/CIR 3/2001, dated October 15, 2001]. ECS facility is extended by Reserve Bank of India (RBI) in 15 Centres, State Bank of India (SBI) in 30 Centres and State Bank of Indore in 1 Centre [Total 46 Centres] as listed below:
RBI : Ahmedabad, Bangalore, Bhubaneswar, Chandigarh, Chennai, Guwahati, Hyderabad, Jaipur, Kolkata, Kanpur, Mumbai, Nagpur, New Delhi, Patna and Thiruvanthapuram. SBI : Agra, Allahabad, Amritsar, Baroda, Bhopal, Cochin, Coimbatore, Dehradun, Durgapur, Faridabad, Ghaziabad, Hubli, Jamshedpur, Kolhapur, Lucknow, Ludhiana, Madurai, Mangalore, Nasik, Panaji, Pune, Rajkot, Shimla, Siliguri, Surat, Trichy, Trichur, Vijayawada, Vishakapatnam and Varanasi.
State Bank of Indore : Indore. Procedure for transfer of unpaid or unclaimed dividend to the Investor Education Protection Fund Sub-section (5) of section 205A provides that, if any, money transferred to an ‘unpaid dividend account’ in a scheduled bank remains unpaid or unclaimed for a period of 7 years from the date of such transfer, the company should transfer the same to the Investor Education and Protection Fund established under section 205C(1). For this purpose the following procedure should be followed by the company: Prepare the statement in the prescribed form stating all sums to be transferred from the unpaid dividend account with the bank to the fund, the nature of the sum, the names and last known addresses of the persons entitled to receive the same, the amount to which each person is entitled and nature of his claim thereto and other particulars prescribed. Get a DD from the bank where the company maintains its unpaid dividend account in favour of Punjab National Bank and remit the amount with any of the specified branch of Punjab National Bank by presenting the challan in triplicate in the prescribed form. The Head of Account in which the amount is to be remitted is:
Major Head 0075 - Miscellaneous General ServicesMinor Head 104 - Unclaimed and unpaid dividends, deposits and debentures, etc., of investors in companies. The remittance should be made within 30 days from the date of expiry of 7 years - Rule 3 of Investor Education and Protection Fund [Awareness and Protection of Investors] Rules, 2001. The bank will return 2 copies of the challan to the company as token of having received the amount. The company should file one copy of the challan with the Registrar of Companies and file with him a statement in Form-I duly certified by a Chartered Accountant or a Company Secretary or a Cost Accountant or the Statutory Auditors. Deduction of tax at source on dividend General Provision. - According to section 194 of the Income-tax Act, a company has to ensure that income-tax is deducted at source from the dividends payable to the shareholders at the appropriate rate as contained in the Annual Finance Act. The tax deducted at source should be rounded off to the nearest rupee as provided in section 288B of the Income-tax Act. The Government has clarified that rounding off is to be done in relation to the total amount of the tax finally payable and not in relation to the amount under the various heads, namely, income-tax, surcharge, etc., (Letter F.N.O. F. No. 12/40/66-IT(B) dated January 25, 1967). Exemptions. - Tax need not be deducted at source on dividend, if the company which pays dividend, is a company in which public are substantially interested and the person who is entitled to the dividend is a resident individual and the dividend does not exceed Rs. 2,500 and it is paid by an account-payee cheque (in the case of a closely held company, tax is to be deducted at source even if the dividend is below Rs. 2,500). Tax at source should not be deducted from the dividend payable to notified mutual funds notified under clause (23D) of section 10 of the Income-tax Act. No deduction of income-tax is to be made on the dividend payable to the Unit Trust of India in view of section 32(2)(a) of the Unit Trust of India Act, 1963. Tax should not be deducted on dividend paid to the General Insurance Corporation of India and its four wholly owned subsidiaries, viz., The National Insurance Company Limited, The New India Assurance Company Limited, The Oriental Insurance Company Limited and the United India Insurance Company Limited in view of section 35A of General Insurance (Nationalisation) Act, 1972. Where the shareholder has filed a declaration in Form No. 15G in duplicate to the company, tax should not be deducted at source from the dividend. If the shareholder has made an application in Form No. 13 to the ITO and the ITO has granted a certificate in Form No. 15 to the company authorising the company to pay dividend without deducting income-tax at source, the company need not deduct income-tax from the dividend payable to the shareholder concerned. Double taxation avoidance agreements and TDS. - Foreign income of a person generally becomes liable to tax in two countries - the country in which the income is earned and the country in which the person is resident. Double taxation of such income is avoided by means of Double Taxation Avoidance Agreement entered into by the Government of India with the Government of other countries under section 90 of the Income-tax Act. The Government of India has entered into agreement for avoidance of double taxation with about 57 countries. In such cases, the rate of tax on dividend income is specified in the agreement. If the rate of tax specified is less than the rate of tax to be deducted at source on the dividend income, the tax to be deducted at source on the dividend is the lower rate. This aspect has to be taken into account while deducting income-tax at source on dividend payable by companies to non-residents. TDS account number. - Every company which pays dividend should have obtained a TDS account number from the assessing authority. If the company has not got the TDS account number, it should apply for allotment of TDS account number to the assessing authority (TDS circle) in Form No. 49B in duplicate within one month from the end of the month in which tax on dividends was deducted. The TDS account number (TAN) should be quoted on all TDS challans, certificates and returns. Some other obligations of company regarding TDS. - The tax deducted at source should be remitted to the Government within 7 days from the date of payment of dividend and the company has to issue a tax deduction certificate in Form No. 16A to the shareholders concerned. The tax deduction certificate should be issued to the shareholder within one month from the end of the month in which dividend warrant was issued [Rules 31(3) of Income-tax Rules, 1962]. The company has to file an annual return in Form No. 26 with the income-tax department on or before 30th April. Further, the company has to furnish an annual return in Form No. 27B on or before 30th April of each year, furnishing details of dividend paid without deduction of tax. The company has to file a copy of the declaration filed by the shareholders in Form No. 15G with the Commissioner, who has jurisdiction over the Assessing Officer on or before 7 days of the month next following the month in which the declaration is furnished to the company. Case of NRI’s. - In case a shareholder entitled to dividend is a non-resident Indian, tax at the appropriate rate has to be deducted at source from the dividend even if the dividend is below Rs. 2,500. However, if the non-resident shareholder has made an application to the ITO in Form No. 13 for grant of a certificate under section 197 for non-deduction of tax at source for dividends and the ITO has granted a certificate in Form No. 15 to the company authorising the company to pay dividend without the deduction of tax, the company should not deduct tax on dividends to the non-resident shareholder concerned. In the case of investments made by the non-residents in the shares issued in accordance with the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, income-tax is to be deducted at source at the rate of 10 per cent on dividends as provided in section 115AC of the Income-tax Act. Wherever dividend is paid to non-residents, the company has to file Form No. 27 to the Assessing Officer having jurisdiction in terms of rule 36A of Income-tax Rules, 1962, within 14 days after expiry of two months from the date of payment of dividend. Case of HUF. - Many HUF’s are now-a-days investing in the shares of companies and such shares are held in the name of the Karta of the family. Wherever the shares are held by the Karta, the exemption provided under section 194, for payment of dividend up to Rs. 2,500 without deduction of tax at source cannot be applied, as a HUF is a distinct entity for income-tax purpose. The exemption for payment of dividend up to Rs. 2,500 without tax deduction at source applies only to resident individuals and not to HUF. Hence, the company has to deduct income-tax at the rates applicable to HUF at the time of paying dividend to the Karta of the HUF.