There are two aspect of profits earned by a company, the first one is dividend and the second one is retained earnings. In general concept, the term ‘dividend’ used to denote the profits of a company distributed to its shareholders.
Dividend is usually payable for a financial year if the amount of distributable profits is available after finalization of accounts and therefore we called it as Final Dividend. Final dividend is declared by the company at its Annual General Meeting (AGM) on the recommendation of the Board of Directors.
Definition of Dividend [Sec. 2(35)]
An inclusive definition has been given in section 2(35) of the Companies Act, 2013 that “dividend” includes any interim dividend. Interim dividends are dividends paid by the Board of directors between two AGM without declaring them at an annual general meeting.
Section 123 of Companies Act, 2013 deals with the provisions relating to the declaration and payment of dividend. This section has further been amended by the Companies (Amendment) Act, 2015.
In exercise of the powers conferred by sub-section (3) of section 1 of the Companies Act, 2013 (18 of 2013), the Central Government appoints the 1st day of April, 2014 as the date on which the provisions of section 123 shall come into force.
Dividend from Profits [Sec. 123(1)(a)]
Dividend shall be declared or paid out of the profits of the company for that year or out of the profits of the company for any previous financial years arrived at after providing for depreciation and remaining undistributed, or out of both. That means a company may pay dividend either from its current year profits or the profits of any previous years.
Dividend from Money provided by CG/SG [Sec. 123(1)b)]
Dividend shall be declared or paid out of money provided by the Central Government (CG) or a State Government (SG) for the payment of dividend by the company in pursuance of a guarantee given by that Government.
Dividend after Depreciation [Sec. 123(2)]
As per section 123(2) of the companies Act, 2013, a company shall declare or pay the dividend for any financial year after providing for depreciation in accordance with Schedule-II of the Companies Act, 2013. Therefore, the depreciation as required u/s 123(1) of the Companies Act has to be provided in accordance with the provisions of Schedule II to the Act.
Transfer to Reserve [First proviso of Sec. 123(1)]
Before the declaration of any dividend by a company in any financial year, it may transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves of the company.
Therefore, the company is free to transfer any part of its profits to the reserves as it deems fit. Thus, the amount transferred out of profits has now been left at the discretion of BOD of the company under the Companies Act, 2013.
Dividend out of Reserve [Second proviso of Sec. 123(1)]
In the event of inadequacy or absence of profits in any financial year, any company proposes to declare dividend out of the accumulated profits earned by it in previous years and transferred by the company to the reserves, such declaration of dividend shall not be made except in accordance with such rules as may be prescribed in this behalf.
The Companies (Declaration and Payment of Dividend) Rules, 2014 provide for the rules for declaring dividends out of the reserves as under:
(a) The rate of dividend declared does not exceed the average of the rates at which dividend was declared by it in the 3 years immediately preceding that year.
However, this rule will not apply if a company has not declared any dividend in each of the three preceding financial year.
(b) The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserves does not exceed an amount equal to 1/10th of the sum of its paid-up capital and free reserves as appearing in the latest audited financial statement.
(c) The amount so drawn must first be utilized to set off losses incurred in the financial year before any dividend in respect of equity shares is declared.
(d) The balance of reserves after such drawal shall not fall below 15% of its paid-up capital as appearing in the latest audited financial statement.
Dividend from Free Reserve [Third proviso of Sec. 123(1)]
No dividend shall be declared or paid by a company from its reserves other than free reserves. That means if any company wants to declare or pay any dividend from its reserves, it should be free reserves.
Dividend after Loss set off [Fourth proviso of Sec. 123(1)]
No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against profit of the company for the current year. Note that the fourth proviso of sub-section (1) of section 123 of Companies Act, 2013 has been newly inserted by the Companies (Amendment) Act, 2015.
Interim Dividend Declaration [Sec. 123(3)]
The interim dividend shall be declared by the Board of Directors of any company during any financial year out of the surplus in the profit and loss account and out of profits of the financial year in which such interim dividend is sought to be declared.
However, if the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding 3 Financial Years.
Deposit Dividend within 5 Days [Sec. 123(4)]
The amount of the dividend, including interim dividend, shall be deposited in a scheduled bank in a separate account within five days from the date of declaration of such dividend. In other words, the amount of dividend (final as well as interim) shall be deposited in a separate bank account within 5 days from the date of declaration.
Dividend to Registered Shareholders [Sec. 123(5)]
Dividend shall be paid by a company in respect of any share therein to the registered shareholder of such share or to his order or to his banker and shall be payable in cash.
However, it is clearly stated in the second proviso of section 123(5) of Companies Act, 2013 that any dividend payable in cash may be paid by cheque or warrant or in any electronic mode to the shareholder entitled to the payment of the dividend.
In accordance with the first proviso of section 123(5), a company may capitalize the profits or reserves 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.
No Dividend to Equity Shareholders [Sec. 123(6)]
A company which fails to comply with the provisions of sections 73 and 74 shall not declare any dividend on its equity shares till such failure continues.