Arryan Mohanty
Published on: April 16, 2022, at 08:41 IST
Introduction
Dividends, Audits, and Accounts must be maintained by every company in the market because they are the foundation of the company’s financial planning. This article discusses the fundamental concepts outlined in the Companies Act of 2013(herein referred to as ‘the Act’).
A company that has been incorporated in accordance with the provisions of the Companies Act, excluding a business incorporated under Section 8, may declare its dividend under Section 123 of the Companies Act, 2013.
There are certain consequences that a company may face if it fails to pay a dividend within the specified term as defined by the law. When a company makes a profit or has a surplus, it can pay a portion of that profit to shareholders as a dividend. Any money that isn’t distributed is re-invested in the company.
Definition of ‘Dividends’
A dividend is a portion of a company’s profits that is legally available for distribution to the company’s shareholders as a return on the share capital that has been subscribed by a shareholder and is paid by the company to the shareholders.
Dividends should only be distributed to the company’s registered shareholders and should never be given in cash.
The term “Dividend” comes from the Latin word “Dividendum”, which meaning “To divide.” When a firm borrows money from its shareholders, it is only natural that the profits are shared.
A dividend is a portion of a company’s profit. Dividends, for example, do not form part of a shareholder’s rights; rather, the right to claim dividends arises only when the corporation declares them.
The term “Dividend” is defined in Section 2(35) of the Act to include any interim dividend. In other words, it means:
- Which is share proportion diffuse amidst shareholders
- Profit-sharing regardless on fix rate or a variable one
- It can be paid on preference or equity share
A company’s annual general meeting determines whether or not to pay dividends. Once the final accounts and amount to be split among various shareholders are finished and available for further distribution, the company declares that for a given financial year.
The final dividend for a given financial year must be issued based on the Board of Directors’ (BOD) decision at the annual meeting.
Interim, on the other hand, will be paid between two annual general meetings of the firm, without even a statement by the Board of Directors (BOD). The amount to be paid is determined and disclosed by the Board of Directors at the annual general meeting, and it cannot be higher than the rate suggested by the board.
Once a company declares a dividend, that sum becomes a debt that the company must pay to its shareholders.
However, before declaring, the corporation must first adopt the account of books, which is a requirement before declaring. If the firm fails to pay the stated amount to shareholders within the specified time, shareholders have the right to sue the corporation to recover the money owed to them as a dividend.
All companies registered under the Companies Act, with the exception of those incorporated and registered under Section 8, are permitted to declare dividends under the Act’s requirements.
Companies registered under Section 8 of the act, such as not-for-profit entities, are prohibited from declaring dividends under the act’s requirements because their primary purpose is to be a non-profit organization.
After paying its creditors, a company might utilize some or all of its remaining revenues to distribute dividends to its shareholders.
However, if a company is short on cash or needs cash for reinvestment, it can choose to forego paying dividends.
When a company declares a dividend, it also establishes a record date, after which all shareholders who were registered on that date are eligible to receive dividends in proportion to their shareholding.
Within a week or so, the corporation normally mails the payments to stockholders. Stocks are generally purchased or sold with dividends until two business days before the record date, at which point they become ex-dividend: According to a study, dividend-paying companies in India declined from 24% in 2001 to around 16% in 2009 before increasing to 19% in 2010.
Some companies in the United States, such as Sun Micro systems, Cisco, and Oracle, do not pay dividends and instead reinvest their entire profit back into the business.
The underlying worth of a company’s share price is usually unaffected by dividend payments. Companies with a fast growth rate and those who are still in the early stages of their business rarely pay dividends since they want to reinvest the majority of their profits to assist them continue to grow and expand.
Established corporations, on the other hand, attempt to reward loyal investors with regular dividends.
Why Companies Pay Dividends
Dividends are paid by companies for a variety of reasons. For investors, these considerations can have a variety of meanings and interpretations.
Shareholders can expect dividends as a return for their faith in a company. The company’s management may strive to honor this opinion by maintaining a strong dividend payment track record.
Dividend payments boost a company’s image and help keep investors on board. Dividends are also preferred by shareholders since, in many countries, they provide tax-free income for them.
Capital gains realized through the sale of a stock whose price has increased, on the other hand, are considered taxable income. Traders looking for quick profits may choose dividend payments because they are tax-free right away.
A high-value dividend announcement can suggest that the business is performing well and is profitable. However, it could also mean that the company lacks viable projects to create higher returns in the future. As a result, instead of reinvesting in expansion, it is paying dividends to shareholders.
If a corporation has a lengthy history of paying dividends, a reduction in the amount or cancellation of the pay-out may indicate to investors that the company is in difficulty.
On Feb. 1, 2022, AT&T Inc. decreased its annual dividend in half to $1.11, causing its stock to drop by 4%.
A cut in dividend payments or a decision not to pay any dividends is not always indicative of negative news for a company.
Given the company’s financials and operations, it’s feasible that management has superior plans for investing the money.
For example, instead of modest earnings from dividend payments, a company’s management may choose to invest in a high-return initiative that has the potential to amplify returns for shareholders in the long run.
Impact of Dividends on Share Price
Dividends are irrevocable; therefore, they usually result in money disappearing from the company’s records and business accounts forever.
As a result, dividend payments have an impact on share prices, which may rise by about the amount of the dividend announced on the announcement and subsequently fall by a comparable amount in the opening session of the ex-dividend day.
For example, a business with a share price of $60 declares a $2 dividend on the day it is announced. The stock price rises by roughly $2 as soon as the news is made public, reaching $62.
Let’s say the stock is trading at $63 one day before the ex-dividend date. Because anyone buying on the ex-dividend day will not receive the dividend, it is adjusted by $2 and begins trading at $61 at the beginning of the trading session on the ex-dividend date.
Procedure to be followed for dividends declaration
- Issuance of a 7-day advance notice time for an annual financial meeting of the board of directors under Section 173 of the Companies Act, 2013.
- In the case of a publicly traded corporation, a two-day notification to the stock market where the company’s securities are traded is required.
- For dividend distribution and issuance, a resolution must be passed at an annual board meeting.
- To ensure that annual dividend tax is paid to the appropriate body, prepare a dividend statement.
- Creation of a separate bank account for the distribution of dividends.
- Dividends are distributed to shareholders in accordance with their shareholding patterns.
Types of Dividends
Final Dividend
A final dividend is the one that is declared at the company’s annual general meeting. Once announced in the meeting, it becomes a legal responsibility for the company.
It is only declared on the Board of Directors’ recommendation.
Interim Dividend
The Board of Directors declares this dividend between the company’s two annual general meetings. Section 123(3) of the Internal Revenue Code allows a company’s board of directors to declare interim dividends from the company’s profits surplus during any fiscal year.
Within five days of the date of proclamation of such dividend, the amount of the dividend, including interim dividend, must be deposited in a scheduled bank in a separate account.
Within five days of the date of declaration of the dividend, including the interim dividend, the amount of the dividend should be deposited in a scheduled bank in a separate account; if the articles of the company do not authorize this, they must be revised accordingly.
The dividends are exclusively paid to registered shareholders, and no pay-outs are paid to stockholders who fail to refund their investment.
Dividend on Equity and Preferential Shares
A company that fails to comply with Sections 73 and 74 will not be able to declare a dividend on its equity shares as long as the failure continues.
Dividends on preferential shares might be in the form of a fixed amount calculated at a fixed rate or a fixed amount calculated in accordance with the articles of association.
The preferential shareholders’ rights to dividends are subject to three basic conditions: preferential dividends can only be paid if the company has sufficient profits, a dividend becomes payable to the shareholders only when it is declared in the manner prescribed by the Act and the company’s articles, and a formal declaration must have been made.
Preference shareholders do not have the right to treat the dividend as a debt and litigate for payment in the first place.
There are two types of preferential shares: cumulative and non-cumulative. Cumulative preferential shares are those shares in which arrears are accumulated for financial years in which dividends are not paid and these accumulated arrears are paid along with dividends in a financial year in which distributable earnings are available.
The non-cumulative preferred stockholders do not have access to the accumulated arrears advantage.
Priority is granted to preferred shareholders over equity shareholders. After all preferential shareholders have received their dividends, a portion of the distributable earnings is paid to equity stockholders as dividends.
If there are no dividends left after preferential shareholders have been paid, no dividend is paid to equity owners for that fiscal year.
Sources of Declaring Dividends
Section 123 of the Act allows a corporation to declare a dividend solely from its profits for that year or any prior financial year after depreciation has been charged and the conditions of Schedule II of the Act have been followed.
Dividends can also be declared using funds provided by the federal government or a state government for the payment of a dividend by a corporation under the terms of a guarantee offered by that government.
Before declaring any dividend, a corporation must deposit the necessary amount of profits for that financial year into its reserves account, and it is required to declare dividends exclusively from free reserves.
According to Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014, in the event of inadequacy or lack of earnings in any financial year, a business can declare dividend out of excess if the following conditions are met:
- The dividend rate declared must not be higher than the average of the dividend rates declared by it in the three years before to that year: This sub-rule does not apply to a corporation that has not declared a dividend in each of the three previous fiscal years.
- The entire amount drawn from such accumulated profits cannot exceed one-tenth of the sum of the company’s paid-up share capital and free reserves as shown in the most recent audited financial statement.
- Any dividend in respect of equity shares must first be used to offset losses made in the financial year in which the dividend is issued.
- After such withdrawal, the balance of reserves must not fall below 15% of the paid-up share capital as shown in the most recent audited financial statement.
- No company may declare or pay a dividend unless it has carried over previous losses and depreciation not provided in previous years and has set off the loss or depreciation, whichever is less, in previous years against the profit of the current year.
Unpaid Dividend Accounts
If a company declares a dividend and the shareholder does not pay or claim it within 30 days of the declaration, the company must transfer the money to an unpaid dividend account within seven days of the expiration of the 30 days.
Any person claiming to be entitled to any money transferred under sub-section (1) to the business’s Unpaid Dividend Account may apply to the firm for payment of the money claimed, according to Section 124(4) of the Act.
Such details about the transfer of money to the unpaid dividend account shall be put on the internet within a period of ninety days after making a transfer in the account.
The published statement should include the names, addresses, and any other websites that have been approved by the central government.
According to Section 127(6), the corporation must transmit the shares relating to unclaimed dividends to the Investor Education and Protection Fund, together with a declaration containing the required information.
Offenses & Penalties
If a company fails to comply with any of the based-on Section 124 of the Companies Act, 2013, which deals with unpaid dividend accounts in the case of unclaimed dividends, the company will be fined not less than five lakh rupees but not more than twenty-five lakh rupees, and each officer of the company who is in default will be fined not less than one lakh rupees but not more than five lakh rupees.
Every company is required to pay its dividends within 30 days of the date of declaration. If the dividend is not paid or the warrant in respect of the dividend is not posted within 30 days from the date of declaration to any shareholder entitled to payment of the dividend, every director of the company, if he is knowingly a party to the default, shall be punished with imprisonment for up to two years and a fine of not less than one thousand rupees for each day during which such default continues, and the company shall be punished.
If a company fails to pay dividends to its shareholders within 30 days of declaring them, it will be held liable under Section 127 of the Companies Act, 2013.
Every director who is a known party to the default will be sentenced to two years in prison, and the company will be liable to pay simple interest at the rate of 18 percent per annum for the period during which the default continues.
The proviso to Section 127, which deals with punishment for failure to transfer profits, provides that no offense is committed in the following situations:
- In the event that the dividend could not be paid due to a legal requirement.
- If the shareholder gives specific directions for the distribution of dividends in a specific manner that are not in accordance with the Act and he has been told of this.
- If there is a disagreement about who has the right to receive dividends.
- If a dividend has been legitimately offset against a payable sum from a shareholder.
- If the failure to pay a dividend or post the warrant within the time frame set out in this section was not attributable to a company default.
Nidhi companies are exempt to the degree that when a member’s dividend is less than Rs. 100, a declaration of dividend must be published in a local newspaper with a broad readership in the local language, and the announcement must be placed on the Nidhi’s notice board for at least three months. This section is complied with if such an announcement is made.
Section 24 of the Firms Act gives on SEBI the authority to administer the regulations relating to non-payment of dividends in the case of listed companies. In any case, the authorities remain in the hands of the federal government.
Every director of the company shall be subject to a term of imprisonment of up to two years and a fine of not less than one thousand rupees for each day that the default continues, and the company shall be liable to pay simple interest at the rate of 18 percent per annum for the period that the default continues.
The offense committed by the company’s director is not compoundable because it is punished by fine and imprisonment under clause (b) of sub-section (6) of section 441 of the Act.
Conclusion
Many precautions have been taken in order to prevent any dividend division and payment defaults. In the event of shareholders, non-payment of the dividend within the stipulated time has been constituted a criminal offense with a penalty.
However, many businesses continue to ignore these laws. Despite the fact that certain exceptions exist, it is the responsibility of every firm and every shareholder to respect the law’s regulations regarding dividend distribution and payment.
References
- Punishment_for_failure_to_distribute_dividends
- dividend
- definition/dividend
- punishment-for-failure-to-distributedividendsThepenaltyincaseoffailuredispersedividendIncaseif&textforacompanyfinecanalongwithfineofRs.
- analysis-dividend-chapter-companies-act-2013
- distributing-dividends-among-shareholders-company
Edited by: Tanvee Jain, Publisher, Law Insider
Also Read: Concept, Development and Procedure of Listing Securities under Companies Act, 2013