Financial Instruments 5
WHEN DIVIDEND IS RESTRICTED
The restriction that the company law puts on declaration of dividends by companies is that they must be paid only out of profits and after providing for depreciation. Of course, losses, if any of the previous years must be set off before declaring dividend.
However, in exceptional circumstances, the Government has the power to exempt a company or a class of companies from the provision of providing depreciation before declaration of dividend. The purpose of imposing this restriction is to ensure that the assets of companies are preserved for the benefit of their creditors and not to be distributed among members of the companies in the guise of dividends.
Payment of Dividend in Cash or in Kind
Dividend can be paid only in cash, not in kind. The articles may provide that any meeting of the company declaring a dividend may resolve that the dividend be paid wholly or partly by distribution or issue of paid-up shares. In the absence of such express authority dividends may not be paid otherwise than in cash. In one case, where the dividend was paid by allotting shares, it was held that the market value of the shares on the date of the declaration of dividend was to be taken into consideration for computing the income of shareholders for the purposes of tax.
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ABOUT DIVIDEND WARRANTS
Any dividend payable in cash may be paid by check or warrant and it shall be deemed to have been paid when the check or warrant therefore is posted to the registered address or to such other address as provided by the shareholder entitled to the payment of dividend. So far as the company is concerned, the person entered in the Register of members is the holder of shares though he may be merely a fake having no beneficial interest in the shares for another person (a beneficiary).
“Dividend warrant” is an order by the company to its banker to pay the amount specified therein to the shareholder whose name is written therein. The shareholder may, at his discretion thereafter draw the amount of the warrant from his account with the bank and with whom he deposits the warrant for collection.
A company cannot take any notice of any private arrangement between the vendor and purchaser of shares. If a dividend warrant issued to but not received by a shareholder, is encashed by an unauthorized person directly or indirectly, the company will have to bear the loss, because in such cases the dividend cannot be said to have been paid to the registered holder.
For this reason, a warning note is printed on the reverse of the dividend warrant to save the company from the liability due to dividend warrant falling in hands of fraudulent persons.
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DIVIDEND IN CASE OF INADEQUATE PROFITS
In case of absence or inadequacy of profits, dividend can be declared out of the accumulated profits earned by the company in the previous years and transferred by it to reserves. Such declaration should be in accordance with the rules prescribed in this regard by the Government. If such a declaration does not conform to the rules, the declaration of dividend will require the previous approval of the Government. Under these rules dividend can be declared from amounts drawn from reserves (that is free reserves only and not from any specific reserves) in case of absence or inadequacy of profits subject to the following conditions:
- the rate of dividend declared shall not exceed the average of the rates of dividend declared by it during the immediately preceding last five years or 10% of the paid-up capital, whichever is less
- the amount to be drawn shall not exceed 10% of its paid-up capital and free reserves and the amount so drawn should be first utilized to set off the losses incurred in the financial years before any dividend in respect of preference as equity shares is declared
- the balance of reserves after such drawal shall not fall below 15% of the paid-up share capital
It should be notes that this rule will not apply to declaration of dividend out of the profits/surplus carried forward to the Balance Sheet by a company. It will apply only to declaration of dividend out of the profits of the previous years transferred to the reserves.
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TYPES OF DIVIDEND
FINAL DIVIDEND
The Board of Directors in its report recommends final dividend to the shareholders, as per the requirements of the Articles of Association and Companies Act that are attached to the balance sheet for the relevant financial year. The shareholders at the annual general meeting declare it. Usually Articles of Association of companies provide that the shareholders cannot increase the rate or amount of dividend than the one recommended by the Board. The shareholders may, however, declare the payment of dividend on equity shares at a rate lower than the one recommended by the directors in their report.
It is the discretion of the Board of Directors to recommend or not to recommend the declaration of final dividend that has to be exercised in good faith in the interest of the company. The shareholders have no power to declare final dividend in the absence of a recommendation of the Board of Directors in this regard.
INTERIM DIVIDEND
The Board of Directors may declare interim dividend. The interim dividend is paid between two annual general meetings of the company.
A company can normally estimate its profits for the current financial year on a fairly reasonable basis and in that event it can allocate to the reserves the prescribed percentage of profits on the basis of its estimated profits. As a measure of precaution, the company may allocate to the reserves a higher amount than the actual amount based on the prescribed percentage of its estimated profits.
Further, it should also provide for depreciation in full. It should transfer to the reserves an amount based on estimated profits after the end of the financial years and before the finalization of the amounts for the financial year and thereafter decide to pay an interim dividend to its shareholders.
Before, a mere resolution for declaration of an interim dividend did not create any liability and could be rescinded at any time before actual payment. This was so even if the cash to cover the proposed dividend had been placed into a separate account. However, now both interim and final dividend when declared become debt and are payable within 30 days of declaration.
DIVIDEND ON PREFERENCE SHARES
A Preference share carries a preferential right as to dividend in accordance with the term of issue and the articles of association, subject to the availability of distributable profits. The preferential right to a dividend could either be a fixed amount or an amount calculated at a fixed rate. It may be cumulative or non-cumulative. Preference shares carry dividend of a fixed amount, before any dividend is paid on the equity shares. If there are two or more classes of preference shares, the shareholders of the class that has priority are similarly entitled to their preferential dividend before any dividend is paid in respect of the other class. But these rights in respect of dividends are subject to three conditions.
Firstly, preference shares are part of the company’s share capital, consequently preference shares preference dividends can be paid only if the company has earned sufficient profits.
Secondly, a dividend becomes payable to the shareholders only when it is declared in the manner laid down in the Act and by the company’s Articles.
Thirdly, there should have been a formal declaration. Preference shareholders are not entitled to treat the preference dividend as a debt and sue for its payment in the first instance. Though, if the articles specify that the company’s profit shall be applied, by way of payment of the preference dividend, the preference shareholder can sue for it even thought is has not been declared.
DIVIDEND ON EQUITY SHARES
Dividend on equity shares is to be paid in accordance with the rights of the respective classes of shares. Equity shareholders are entitled to be paid dividend on their shares only after all dividends on preference shares have been paid to date. Although the equity shareholder stands second in preference to preference shareholders, he enjoys a privilege of a higher dividend as the preference dividend is fixed and cannot be increased, however large the company’s profits may be, unless the preference shares carry the right to participate in surplus profits. Except in that case, therefore, the whole of the residual profits of the company after paying the preference dividend may be paid out as dividend to the equity shareholders either immediately or in later years.
Note: The profits of a business means the net proceeds of the concern after deducting the necessary expenses without which those proceeds could not be earned.
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WHAT IS DIVIDEND?
THE DEFINITION
Dividend is the return on the share capital subscribed for and paid to a company by its shareholders. The dictionary meaning of the term “dividend” is sum payable as interest on loan or as profit of a company to the creditors of an insolvent’s estate or an individual’s share of it. In commercial parlance, however, dividend is the share of the company’s profit distributed among the members.
THE DIFFERENCE BETWEEN DIVIDEND AND INTEREST
- While dividend is paid on preference and equity shares, interest is paid on debentures and long term and short term loans/borrowings including fixed deposits.
- Interest is a debt that like all debts is paid out of the company’s assets generally. A dividend however, becomes a debt only after the company has declared it.
- Dividend cannot be paid out of the assets of the company, generally it can be declared only out of the profit available for the purpose.
- Interest is a charge on profits while dividend is an appropriation of profits.
- The power to pay dividend is inherent in a company and is not derived from the Companies Act nor the Memorandum or Articles of Association, although the Act and the Articles generally regulate the manner in which dividends are to be declared.
- Right to claim dividend will only arise after the company in general meeting declares a dividend and until and unless it is so declared, the shareholder has no claim against the company in respect of it.
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