What Is a Dividend?

A dividend is a distribution of a company’s post-tax profits to its shareholders. The profit of a company is in principle for the benefit of its shareholders.

Chapter VIII (Declaration and Payment of Dividend) of the Companies Act, 2013 Opens in a new window together with the Companies (Declaration and Payment of Dividend) Rules, 2014 Opens in a new window regulate distributions by Private Limited Company including dividends.

For a company to be able to lawfully pay a dividend, it must have sufficient distributable profits (see How to Determine if a Company Can Pay a Dividend). A company that has accumulated losses cannot pay a dividend. The profits of a company are in principle for the benefit of its shareholders.

Dividends are not payable except in cash.

Any dividend paid out by a private company will be either a final dividend or an interim dividend (see Final Dividends vs Interim Dividends). The dividend may be a usual dividend paid periodically during the private company’s financial year as a reflection of its ongoing performance or it may be a one-off special or pre-sale dividend (such as an interim dividend), or a fixed dividend that is paid to the holders of preference shares.

Why Pay a Dividend?

Companies pay dividends to reward their shareholders as they provide available share capital to the private company, to provide them with a return on their investment, and to maximise shareholder value in that way. Many private subsidiary companies of multinationals use dividends to repatriate local profits up to their parent companies.

How to Determine if a Company Can Pay a Dividend

A Private Limited Company may only pay dividends in any financial year:

• Out of the profits of the private company Opens in a new window for that financial year after providing for depreciation, or out of the profits of the private company Opens in a new window for any previous financial year Opens in a new window after providing for depreciation, or out of both.
• Out of the money provided by the Central Government or a State Government for the payment of dividend Opens in a new window by the private company Opens in a new window further to a guarantee given by that government.

To determine payment of dividends:

• The “profits of the private company” means the profits as set out in the statement of profits and losses which forms part of the audited financial statements of such private company for that financial year prepared in accordance with the Indian Accounting Standards (Ind AS) or other generally accepted accounting principles, as applicable, as audited by the statutory auditors of the private company, approved by the board of directors of the private company and adopted by the shareholders of the private company at the annual general meeting held for that financial year.
• The “depreciation” means the depreciation of the assets of the private company calculated in the manner prescribed in Schedule II (Useful Lives to Compute Depreciation) of the Companies Act, 2013.

How to Declare a Dividend

In computing profits of a private company, any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value is to be excluded.

A private company Opens in a new window may, before the declaration of any dividend Opens in a new window in any financial year Opens in a new window, transfer such percentage of its profits for that financial year Opens in a new window as it may consider appropriate to the reserves of the private company.

Where, due to inadequacy or absence of profits in any financial year Opens in a new window, any private company Opens in a new window proposes to declare dividend Opens in a new windows out of the accumulated profits earned by it in previous years and transferred by the private company Opens in a new window to the free reserves:

• The rate of dividend declared cannot exceed the average amount of dividend declared by it over the three financial years immediately preceding that year. However, this rule does not apply to a private company which has not declared any dividend in each of the three preceding financial years.
• The total amount to be drawn from such accumulated profits cannot exceed one-tenth of the sum of its paid-up share capital and free reserves as they appear in the latest audited financial statement.
• The amount drawn should first be used to set off the losses incurred in the financial year in which dividend is declared before any dividend in respect of equity shares is declared.
• The balance of reserves after such withdrawal cannot fall below 15% of its paid-up share capital as it appears in the last audited financial statements.

Dividend Opens in a new windows cannot be declared or paid by a private company Opens in a new window from its reserves other than free reserves Opens in a new window.

A private company Opens in a new window cannot declare dividend Opens in a new window unless carried over previous losses and depreciation not provided in the previous year or years are set off against profit of the private company Opens in a new window for the current year.

Shareholders Resolution to Declare a Dividend

Based on the specific recommendation of the board of directors, the shareholders of a private company may, at the annual general meeting, declare the payment of dividends after adopting the audited financial statements for that financial year. The declaration of payment of dividends by the shareholders is to be made by way of an ordinary resolution through a simple majority of votes, unless a stricter threshold is specified in the articles of association of the private company. The shareholders may decide to declare dividends at a rate lower than that recommended by the board of directors, but do not have the power to increase the rate of dividend recommended by the board of directors. The shareholders may also decide not to declare the amount of dividends recommended by the board of directors.

Board Approval

The board of directors of the private company, may at its sole discretion, recommend the declaration of dividends by the shareholders of the private company for any financial year either by way of a resolution passed at a meeting of the board or by way of passing a circular resolution (without convening a meeting of the board of directors). If a private company has or requires an audit committee, such audit committee should consider the annual financial statements on the basis of which the dividends are proposed to be declared, before submitting it to the board of directors.

Dividends cannot not be declared subject to any conditions. All requisite approvals, including third party approvals from financial institutions or banks or foreign entities with which the Indian company has technical or other collaborations or compliance with any other contractual obligation should be obtained before declaration of dividend.

The recommendation of the board of directors to declare dividends is subject to approval by the shareholders of the private company (see Shareholders Resolution to Declare a Dividend). The board may revoke its recommendation to declare a dividend any time prior to the approval and declaration of the dividend by the shareholders based on the recommendation of the board of directors. If the recommendation of the board of directors to declare a dividend is revoked, the shareholders cannot insist on declaration and payment of such dividends.

Directors Duties and Liabilities in the Context of Dividends

Where a dividend Opens in a new window has been declared by a private company Opens in a new window but has not been paid or the warrant in respect of it (see Method of Payment) has not been posted within 30 days from the date of declaration to any shareholder entitled to the payment of the dividend Opens in a new window, every director Opens in a new window of the private company Opens in a new window who is knowingly a party to the default is punishable with imprisonment which may extend to two years and with a fine not less than INR1,000 for every day during which such default continues.

Exceptions to this are:

• Where the dividend Opens in a new window could not be paid by reason of the operation of any law.
• Where a shareholder has given directions to the private company Opens in a new window regarding the payment of the dividend Opens in a new window and those directions cannot be complied with and the same has been communicated to the shareholder.
• Where there is a dispute regarding the right to receive the dividend Opens in a new window.
• Where the dividend Opens in a new window has been lawfully adjusted by the private company Opens in a new window against any sum due to it from the shareholder.
• Where, for any other reason, the failure to pay the dividend Opens in a new window or to post the warrant within the period under this section was not due to any default on the part of the private company.

Provisions in Articles of Association and Shareholders’ Agreement

Before declaring and paying a dividend, the Private Limited Company’s articles of association and any applicable shareholders’ agreement should be checked as they usually contain express provisions regarding dividends.

The articles of association or the shareholders’ agreement (or both) of the Private Limited Company can, and commonly do, contain:

• A requirement for the approval of lenders or the holders of a specific class of shares or investors (or both) or other third parties for any dividends being paid (where the private company has lenders or specific classes of shares or investors or other third party arrangements with such obligations on the private company).
• Either an obligation to pay dividends where legally permissible or a restriction or prohibition or approval requirement to pay dividends altogether (by ensuring any profits made are added to the private company’s reserves or declare dividends only after seeking an approval).
• Weighted voting and quorum requirements in respect of (shareholders’ or other authorised corporate body’s) resolutions to approve and pay dividends.
• Special rights of certain shareholders in respect of dividends, such as a priority right for any dividend for the holders of preferential shares.
• Shares with (cumulative) preferential rights to any dividends being paid (preferential shares).
• A provision that the distributable profit is for the benefit of certain persons (such as a manager’s share in profits).

Amount of the Dividend

Dividends are declared and paid according to the amounts, which are mandatorily paid up on the nominal value of the shares of a Private Limited Company. Shares with a higher nominal value will be entitled to a higher dividend, depending on class rights.

The payment of the dividend does not take into account:

• The part of the issued capital that is not paid up (and which has not been called).
• Any legally permissible amounts which are voluntarily paid up on shares.
• Any share premiums.

The articles of association of a Private Limited Company may provide otherwise, subject to inclusion of provisions enabling grant of differential rights. Shareholders may also unanimously resolve to pay a particular dividend differently, for example, that the whole of the dividend is paid to one shareholder only or that share premiums are taken into account when making the calculation.

Subject to the abovementioned differential rights, to calculate the amount of a dividend to be paid, the relevant allocated profit is divided over the total number of the issued shares. Any special rights to dividend will also have to be considered.

Dividends do not carry interest against the private company except in case of default in payment of declared dividend or dispatch of the dividend warrant or cheque within the prescribed time period.

Right to a Dividend

All shares are in principle equally entitled to dividend as all shares in principle have the same rights in proportion to their amount.

The articles of association can, however, provide otherwise, subject to inclusion of provisions enabling grant of differential rights. The articles of association can provide for different classes of shares, with different rights to dividends, such as (cumulative) preferential shares.

All holders of equity shares or preference shares on the shareholders register of a private company or statement of beneficial ownership furnished by the depository or depositories as on the record date fixed by the private company will be entitled to that dividend unless the private company’s articles of association provide otherwise. For example, the articles may provide that only shareholders on the register of members at a certain record date will be entitled to a predetermined dividend.

Preference shares carry a preferential right to dividends in accordance with the terms of issue (Proviso to Section 43, The Companies Act, 2013). However, this right is subject to the availability of distributable profits (Section 123(1), The Companies Act, 2013). If there are two or more classes of preference shares, the holders of the class which has priority are entitled to their preference dividend before any dividend is paid in respect of the other class, if the terms of issue so provide. However, if the terms of issue are silent, dividend will be distributed on pro-rata basis. In the case of interim dividend, while preference shareholders need not necessarily be paid dividend before interim dividend is paid to equity shareholders, the board of directors should take into account such sum as would be necessary to pay fixed dividend to the preference shareholders before consideration of interim dividend.

Preference shares may be cumulative or non-cumulative. Dividend in arrears on cumulative preference shares can be paid in a later year where there are profits to justify such payment. In the case of non-cumulative preference shares, if no dividend is paid in a year, there is no right to receive the same in future years. After paying the dividend on preference shares and any arrears of dividend on cumulative preference shares, residual profit may be used for payment of dividend to equity shareholders. However, where participating preference shares have been issued, the holders of them also have the right to participate in such residual profit, subject to the terms of issue of such shares (Paragraph 3.3, Secretarial Standard on Dividend (SS-3), The Institute of Company Secretaries of India).

Preference shareholders of a private company are only entitled to voting rights with respect to resolutions which affect the rights attached to such preference shares or which are in respect of the winding up of the private company Opens in a new window, repayment or reduction of the private company’s equity or preference share capital, unless the memorandum or articles of association of such private company permit preference shareholders to vote on any other resolutions placed before the private company. However, if dividend in respect of a class of preference shares is not paid for two years or more, such class of preference shareholders will have a right to vote on all the resolutions placed before the private company, irrespective of whether such right is specifically granted in the memorandum or articles of association of such private company (Second proviso to Section 47(2), The Companies Act, 2013)..

Where a private company issues equity shares with differential rights as to dividend, the terms of issue of such shares shall govern the rights of each such class of holders as to receipt of dividend (Section 43(a)(ii), The Companies Act, 2013 together with Rule 4, The Companies (Share Capital and Debenture) Rules, 2014).

Final Dividends vs Interim Dividends

Any dividend paid out by a private company will be either a final dividend or an interim dividend. Final dividends are paid once a year and are calculated after the annual accounts have been adopted and once a Private Limited Company’s profits are determined.

Interim dividends may be declared by the board of directors of a private company out of the surplus in the profit and loss account or out of profits of the financial year Opens in a new window for which such interim dividend Opens in a new window is sought to be declared or out of profits generated in the financial year Opens in a new window until the quarter preceding the date of declaration of the interim dividend. Where a private company has or requires an audit committee, this committee should consider the financial results which shall then be submitted to the board of directors for its consideration and declaration of interim dividend.

While declaring the interim dividend, the board of directors should consider the financial results for the period for which interim dividend is to be declared and should be satisfied that the financial position of the private company justifies and supports the declaration of such interim dividend. The financial results should take into account:

• Depreciation for the full year.
• Tax on profits of the private company including deferred tax for full year.
• Other anticipated losses for the financial year.
• Dividend that would be required to be paid at the fixed rate on preference shares.
• The losses incurred, if any, during the current financial year up to the end of the quarter, immediately preceding the date of declaration of interim dividend. If the private company Opens in a new window has incurred loss during the current financial year Opens in a new window up to the end of the quarter immediately preceding the date of declaration of interim dividend Opens in a new window, such interim dividend Opens in a new window cannot be declared at a rate higher than the average dividends Opens in a new window declared by the private company Opens in a new window during the immediately preceding three financial years Opens in a new window.
• See How to Determine if a Company Can Pay a Dividend for the manner of determining final dividends.

Currency

Usually, dividends will be paid in Indian rupees. Dividends may also be paid in foreign currency, subject to the applicable provisions of the Foreign Exchange Management Act, 1999 and the rules and regulations made under it.

A private company’s articles of association or a shareholders’ agreement (or both) may hold provisions in this respect.

Method of Payment

Most cash dividend payments in India are made electronically. To this end, shareholders must inform their company of their banking details.

Dividends may also be paid by way of cheque or warrant. A dividend warrant is an order of payment issued by a private company evidencing that a shareholder is entitled to payment of dividend and directing the bank to pay the dividend amount to the shareholder specified in the dividend warrant.

Accounting Treatment of Dividends

All Indian companies must comply with the following accounting standards that specify the treatment of events after the balance sheet date but before the accounts are approved for issue:

• Indian Accounting Standards (Ind AS) in accordance with the Companies (Indian Accounting Standards) Rules, 2015.
• If they have not adopted Ind AS, then Indian GAAP in accordance with the Companies (Accounting Standards) Rules, 2006.

Recent Developments

In The Plate Dealers Association Private Limited & Ors v Satish Chandra Sanwalka & Ors (2016) 10 SCC, the board of directors of the private company had passed a resolution approving the conversion of 3065 preference shares held by certain shareholders of the company into 3065 equity shares on the basis that dividends in respect of the 3065 preference shares had not been paid and in lieu thereof, the shareholders had agreed to receive an equal number of equity shares.

The Supreme Court of India ruled that such conversion should be invalidated as there was no clarity on the period for which the dividends remain unpaid, the quantum of unpaid dividends or any information to show that the 3065 equity shares issued in lieu of dividend represented the true value of the dividends claimed to be unpaid.

This article was originally published in Thomson Reuters on 2 January 2024 Co-written by: Sarika Raichur, Partner; Sharon Pothigai, Senior Associate. Click here for original article

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