Important Considerations While Declaring Dividends

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Submitted by Richard Gere at Dividend Investor part of our contributors program.

Many companies provide shareholders a payout from their profit earnings. Generally company gives this payment on a quarterly or in yearly basis in the form of dividend. The company frequently pays dividends as a stock or in the form of cash. In that case, the company must follow certain rules and regulations for declaring dividends.

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Determine some provisions while declaration and payment of dividend

In the Companies Act, 1956, Transfer of Profits to Reserve rules, 1975, Companies (Declaration of Dividend out of Reserves) Rules, 1975 provide the provision governing declaration and payment of dividend by a company. In case companies listed on the Stock Exchanges, the relevant clauses of listing requirements are to be followed. The Companies Act allows dividends to be paid out of three sources; the profits of the company for the year for which dividends are to be paid, undistributed profits of the previous financial years, moneys provided by the Central Government or a State Government for the payment of dividends in pursuance of a guarantee by the Government concerned.

A company cannot declare dividend in the following situations:-

  • When a Company is not having profit i.e. (Loss making company).
  • When a Company fails to redeem its preference shares as per the provisions of Section 80A of the Companies Act. (Sub Section 2B).
  • A Company cannot declare a dividend without the prime approval of Financial Institution, in case if the covenants of the loan agreement stipulate in this regard. Section 205 (3) stipulates that no dividend shall be payable except in cash.
  • Dividends cannot be declared out of the Securities Premium Account or the Capital Redemption Reserve Account or Revaluation Reserve or Amalgamation Reserve or out of the Profit on re-issue of forfeited shares or out of profit earned prior to the incorporation of the Company.

According to the Companies (Transfer of Profits to Reserves) Rules 1975, before declaration or payment of dividend, profits shall be compulsorily transferred to reserves at the following rates:

Rate of proposed dividend Amount to be transferred to the Reserves
Not exceeding 10% Nil
Exceeding 10% but not exceeding 12.5% 2.5% of  current profits
Exceeding 12.5% but not exceeding 15% 5% of current profits
Exceeding 15% but not exceeding 20% 7.5% of current profits
Exceeding 20% 10% of current profits

Procedure of dividends declaration:

A company who wants to declare and pay Indian dividend should follow the following procedures.  If the company’s shares are listed on the Stock Exchanges, additional requirements relating to Listing Agreements are to be followed.

  1. Approval by the Board of Directors: – Dividend can be declared only on the approval of the Board of Directors of the Company. The shareholders do not have the power to declare it. After considering and approval of the financial statements of the company by the board of directors, determine the rate of Dividends which would be declared, then recommends the same to the holders. The agreement becomes public record and is noted in the board of meeting minutes.
  2. Approval by the Shareholders: – Generally public companies do one meeting with shareholders each year. While approving the rate of dividend at the annual meeting, the shareholders have the power to declare a lower rate of dividend than what is recommended by the Board of directors but they have no power to increase the amount or the rate of dividend which is recommended by the Board of Directors.
  3. Dividend now includes interim dividend: – After the Companies (Amendment) Act, 2000, interim dividend is now known as a part of final dividend (clause 14A of Section 2).
  4. Report the Dividend: – A company reports a dividend to the stock exchange on which the security is traded. On the behalf of report, a company must complete a form that corresponds with the dividend payout type, like a stock or cash. This form is usually sent electronically (via email) to the stock exchange.
  5. Dividend to be deposited in a separate bank account or paid by check or warrant: – Within five days of its declaration the Company should deposit the dividend amount including interim dividend in the separate bank account which is opened for this purpose. According to Section 205 (5) (b) of the Companies Act, 1956 provides that the dividend payable in cash may be paid either by check or warrant.

Bottom line:

A company can pay or declare dividend only if it gains profit. The shareholders can also get bonus shares, right shares in this case. If the dividend, which shareholder are getting, is tax free then it is more beneficial for them. Now the dividend is considered as paid in cash, it is one of the best things which a company can do for their shareholder to grow their wealth. A company should always remember some things before declaring dividends to gain the profit. Thus the consistent dividend paying company is the best investment option for all the investors.

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