Dividends and Divisible Profits, Rules Regarding Dividends and Divisible Profits

Dividends and Divisible Profits
Rules Regarding Dividends and Divisible Profits
Auditing Notes B.Com 6th Sem CBCS Pattern

MEANING OF DIVIDEND AND ITS TYPES

Shareholders expect some return for the money invested by them in the company. They get the return on their investment in the form of dividends given to them from time to time. Thus, dividends are the profits of the company distributed amongst the shareholders. The company may declare dividends in general meeting, but no dividend shall exceed the amount recommended by the Board of Directors. Thus, shareholders in annual general meeting can only reduce the amount of dividends but cannot increase the amount of dividends recommended by the Board of Directors. The directors may no recommend dividend even if there are profits if they think that distribution of dividend will impair the financial position of the company.

Dividends are usually paid on the paid up value shares in the absence of any indication to the contrary in the Articles of Association. For example, if a company has share capital of 1,00,000 equity shares of Rs. 10 each, Rs. 7 per share called up, and paid up and if the rate of dividend is 15%, total dividend paid will be 15% of Rs. 7,00,000 paid up capital (i.e. 1,00,000 shares @ 7 each) i.e. Rs. 1,05,000.

Sources of Declaring Dividend

As per Section 123 of the Companies Act, 2013 dividend may be declared out of the following three sources:

1)      Out of Current Profits: Dividend may be declared out of the profits of the company for the current year after providing depreciation. The company must transfer the prescribed percentage of its profits to general reserve before declaring dividends. This percentage depends on the percentage of dividend declared.

2)      Out of Past Reserves: Dividend may be declared out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with the provisions of Schedule II of the Companies Act, 2013 and remaining undistributed. Section 123 of the Act, requires that dividend can be declared out of the reserves only in accordance with the rules framed by the Central Government in this behalf.

3)      Out of Money provided by the Government: A company can also declare dividend out of the moneys provided by the Central Government for payment of such dividend in pursuance of guarantee given by the Government.

Dividends may be of the following two types:

1)      Interim Dividend.

2)      Final Dividend.

Interim Dividend: 

This dividend is declared between two annual general meetings. Section 123 of the Companies Act, 2013 provides that the Board of Directors of a company may declare interim dividend during any financial year out of the surplus in the profit and loss account and out of profits of the financial year which interim dividend is sought to be declared. It further provides that in case 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 no be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years. The Board may from time to time pay to the shareholders such interim dividends as appear to it to be justified keeping in view the profits of the company.

Final Dividend: 

It is a dividend which is declared at the annual general meeting of the shareholders and is declared by the shareholders only on the recommendation of the directors. The dividend proposed by the directors is provided for in the final accounts of the company and is paid only after it has been passed at the annual general meeting of the shareholders.  

Corporate Dividend Tax: 

As per the Finance Act, 1997 dividends paid or declared were subject to corporate dividend tax @ 10% with effect from 1^st June, 1997. Such corporate dividend tax is deducted from Surplus sub-head in the Balance Sheet and it is also shown under the heading current liabilities as a provision till it is paid. But as per recent Finance Act, the rate of this tax is 15% plus 10% surcharge and cess of 2%. Total percentage of corporate dividend tax with surcharge and education cess comes to 17% approximately.

Divisible Profits and Rules regarding Dividends and Transfer to reserves

The term “Divisible Profit” is a very complicated term because all profits are not divisible profits. Only those profits are divisible profits which are legally available for dividend to shareholders. Dividends cannot be declared except out of profits, i.e. excess of income over expenditure; ordinarily capital profits are not available for distribution amongst shareholders because such profits are not trading profits. Thus, profits arising from revaluation or sale of fixed assets or redemption of fixed liabilities should not be available for distribution as dividend amongst shareholders. The principles of determination of the divisible profit are given below:

1)      According to Section 123 of the Companies Act, 2013 no dividends can be declared unless:

Ø  Depreciation has been provided for in respect of the current financial years for which dividend is to be declared;

Ø  Arrears of depreciation in respect of previous years have been deducted from the profits; and

Ø  Losses incurred by the company in the previous years.

2)      Section 123 of the Companies Act, 2013 provides that before any dividend is declared or paid a certain percentage of profits for that financial year depending upon the rate of dividend to be paid or declared should be transferred to the reserves of the company.

Provided that nothing in this sub-section shall be deemed to prohibit the voluntary transfer by a company of a higher percentage of its profits to the reserves in accordance with such rules as may be made by the Central Government in this behalf.

3)      No dividend shall be payable except in cash;

4)      There is no prohibition on the company for the capitalization of profits or reserves of a company for the purpose of issuing fully paid-up bonus shares or paying up any amount for the time unpaid on any shares held by the members of the company.

5)      Any dividend payable in cash may be paid by cheque or warrant sent through the post directed to the registered address of the shareholder entitled to the payment of the dividend or in the case of joint shareholder to the registered address of that one of the joint shareholder which is first named on the register of members or to such person and to such address as the shareholder or the joint shareholder may in writing direct.”

Transfer to Reserves: Section 123 of the Companies Act, 2013 provides that

No dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Schedule II, except after the transfer to the reserves of the company a certain percentage of its profits for that year as specified:

                                 i.      Where the dividend proposed exceeds 10 percent but not 12.5 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 2.5 percent of the current profits;

                               ii.      Where the dividend proposed exceeds 12.5 percent but does not exceeds 15 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 5 percent of the current profits;

                             iii.      Where the dividend proposed exceeds 15 percent, but does not exceed 20 percent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 7.5 percent of the current profits; and

                             iv.      Where the dividend exceeds 20 percent of the paid-up capital, the amount to the transferred to reserves shall not be less than 10 percent of the current profits.