Funds are a must for starting a company. The shareholders contribute to the capital of the company. These shareholders are entitled to a share in the profits which the company makes. However, not all the profits made by the company is to be distributed to the shareholders.
Only divisible profits are available for distribution to the shareholders. The Companies Dividend Rules, 2014 are applicable in declaration and payment of the dividends by the company.
What is Meant by Divisible Profits?
Divisible profits have not been defined anywhere in the Companies Act, 2013. Divisible profits are that portion of the profit which can be distributed legally amongst the shareholders of the company. These profits are distributed by way of dividends. But these profits should be distributed only after the provisions for past losses or reserves have been made.
The divisible profits of the company mean “profits available for recommendation and distribution as dividends after setting aside to reserve or after carrying forward such amounts as the directors deem fit. Even the whole of the profit for the year can be carried forward.”
Like divisible profits, the term profit too has not been defined by the Act. Regardless, profit can be anything earned in excess over the expenditure. In other words, an amount of income which is left after making all the necessary expenditure and deductions like those of taxes, is nothing but profit.
Profit can be either revenue profit or Capital profits or both. Thus, dividend can’t be paid by the revaluation of assets, as the surplus has not been actually realized.
The profit arising from the sale of a business was treated as a profit available for distribution as a dividend. The objection was raised on the ground that the profit was a capital profit as it was realised on the sale of a part of the business. The court observed that the profits was on capital and, therefore, not a part of the capital itself, and held that it should be available for dividend if the Articles of Association so provide.
It should be noted that not every profit of the company is divisible. Also, a number of factors are required to be considered in order to determine the divisible profit of the company.
The profits available for distribution as dividend have to be distributed in accordance with the provisions of the Companies Act as well as the provisions of the Articles of Association.
What is Meant by Dividends?
Dividends are a form of reward that the company gives to its shareholders. Dividends can be given either in cash or in the form of stocks or in any other form. The Board of Directors decide the company’s dividends, but it requires the approval of the shareholders.
The Board of Directors is at discretion to recommend or not recommend a dividend for any year financial year. If any dividend has not been recommended by the Board of Directors, the same cannot be considered or approved for payment by the company. And if the rate of dividend has been recommended by the Board of Directors, the company cannot increase the recommended rate. Thus, the board of directors has the discretion to declare a dividend and the rate of such dividend.
According to Sec 2(35) of the Companies Act 2013, dividend includes interim dividend as well.
An interim dividend is a dividend that is paid for the current year even before the year closes. Only the Board of Directors has been empowered to declare an interim dividend. However, while deciding this the directors of the company have to be extremely careful since the profits cannot be calculated exactly since the accounts have not been closed yet.
If after paying the interim dividend it is learnt that the profits of the company are not adequate to cover the dividend, then the directors have to pay such amount. Hence, to avoid this, the Directors usually get the accounts ready till a certain date before declaring the dividends. However, this is not a final dividend. The Directors can recommend another dividend when the accounts are closed, and the final profit has been calculated.
Dividends are distributed to 2 kinds of shareholders, viz., equity shareholders and preferential shareholders. The latter ones are at a lower risk in any manner. They are preferred over the equity shareholders i.e., to say that first it’s the preferential shareholders whose dividends are settled. Even when the company is winding up, the dividends are distributed to the preferential shareholders first. The equity shareholders, though real owners of the company, are settled only after preferential shareholders are settled.
The Companies Act ,2013 is liberalized in terms of distribution of dividend.
Section 123 of the Companies Act, 2013
According to the section, a company cannot declare or pay dividend for any financial year except for, (i) out of profits or (ii) out of money provided by Central or State Governments.
- Out of Profits
A company can pay dividends out of profits from the current year or any previous year or both. If in the current year the company has incurred losses but has certain profits undistributed from previous years, those profits can be distributed as dividends in the current year. But the dividends have to be declared only after providing for the depreciation.
Unlike the provisions of Companies Act, 1956 which mandated the transfer of profit to general reserve before declaring dividend, section 123 (1) of the Act of 2013 provides that the company is at discretion to transfer the profits to reserve at a rate it deems fit before declaring the dividend.
If the company proposes to carry any amount out of profit to its reserves, then the board of Directors are required to provide for the particulars of such amount.
- Out of money provided by Central or State Government
Divisible profits can also be provided out of the funds given by the Central or State Government. But before declaring the dividends out of the Government funds, the company may transfer a percentage of its profit for the financial year to the reserves of the company.
Depreciation has to be charged before the declaration and distribution of the dividends. The more the depreciation, the less the divisible profit. Less the depreciation more will be the profit.
It is understood that dividend is a portion of the profit that is declared and distributed after depreciation for current of previous years has been provided. The company can distribute dividends for the current financial year or previous years. The dividends can be distributed to the shareholders by way of cash, warrant or cheque. It can also be given through electronic mode. The Companies Act, 2013 provides relaxations in terms of payment of dividends.
- Bueons Airs Great Southern Railway Co. vs. Preston (1947)
- CS DiveshGoyal, Dividend Under Companies Act, 2013, 4 Sep 2016,https://taxguru.in/company-law/dividend-companies-act-2013.html(last accessed on 26 Jan, 2019)
- Lubbock, vs. British Bank of South America Ltd. (1892)
- Maharani Lalita Rajya Lakshmi v Indian Motor Co. (Hazaribagh) Ltd. (1962) 32 Comp Cas 207
- Section 134 of the Companies Act, 2013