One of the most significant factors in corporate financial management is a domestic company’s dividend distribution. It is the dividend that shareholders receive from their investment in the company and their trust in it. Nevertheless, in India, there exists a rigid legal framework that regulates dividend distribution under the Companies Act 2013, which secures transparency, fairness, and accountability in corporate governance.
This paper describes the legal requirements, processes, and qualifications for disclosing and paying dividends, as defined by the Companies Act, 2013, as well as the rules allied to it.
Understanding Dividend under the Companies Act, 2013
A dividend refers to a share of the profit of a company that is given out to its shareholders. Section 2(35) of the Companies Act, 2013 states that dividends are also inclusive of interim dividends and final dividends. It is typically made in cash, but may also be made in kind (e.g. bonus shares).
Simply put, it is how the company shares with its owners, the shareholders, its profits without leaving it with a lot of funds to grow and operate in the future.
Legal Provision Governing Dividend Distribution
Dividend distribution by a domestic company is mostly regulated by Sections 123 to 127 of the Companies Act, 2013, and the Companies (Declaration and Payment of Dividend) Rules, 2014.
These sections provide definite guidelines to make declarations, payments, sources of dividends, transfers to reserves and penalties in case of non-compliance.
Sources of Dividend
Under Section 123(1) of the Act, a company is only allowed to declare a dividend using the following sources:
- Profits of the current financial year after allowing depreciation.
- Profits of the past financial years after deduction of depreciation.
- The Government money (in case of a government company).
In case a firm announces a dividend using a reserve, it is obligated to use the conditions provided by the Companies (Declaration and Payment of Dividend) Rules, 2014.
Requirements for Declaration of Dividend
In order to declare and issue dividends, a company has to meet the following conditions:
- All assets have to be depreciated according to Schedule II of the Act.
- The dividend has to be claimed after taking into consideration the losses incurred in the past years.
- Transfer to Reserves: A company can, of its own accord, transfer part of its profits to reserves prior to declaration.
- Dividend may not be paid on unrealised profit (e.g. revaluation of assets).
- Only a declaration of dividend can be made out of free reserves (not capital or securities premium).
The conditions guarantee that the dividend is only announced based on the actual, realized earnings, and safeguard the financial sustainability of the company.
Procedure for Dividend Declaration and Distribution
The process of dividend declaration and distribution under the Companies Act 2013 has several steps to be followed in order to achieve transparency and compliance.
1. Board Meeting and Recommendation
This is done by the Board of Directors, which has a meeting to look into the financial performance of the company and then suggests the rate of dividend to the shareholders. The recommendation shall be put within minutes of the Board meeting.
2. Approval of Shareholders during Annual General Meeting (AGM)
In case of final dividends, shareholders have to pass the recommendation during the Annual General Meeting (AGM). But in the case of interim dividends, the Board has the power to make the declaration without the consent of the shareholders.
3. Dividend Amount to be Deposited in a Separate Bank Account
Under Section 123(4), the company should have the amount of total dividend deposited in another bank account within a period of five days after the declaration date. This is to ensure that the dividend funds are maintained as separate company funds.
4. Dividend Payment to the Shareholders
According to Section 127, the dividend should be distributed within a period of 30 days after the declaration date. It can be paid:
- In money (through cheque, warrant or electronic transfer).
- In kind (such as bonus shares).
5. Deferral of Unpaid Dividend to Unpaid Dividend Account
Unpaid or unclaimed dividends after 30 days should be transferred to the Unpaid Dividend Account within 7 days.
In case of not paying within 7 years, it should be transferred to the Investor Education and Protection Fund (IEPF) according to Section 124(5).
Interim Dividend
Under Section 123(3), the Board may declare an interim dividend between two AGMs. It is normally announced when the company makes profits that are substantial in the course of the year in which the accounts were prepared before finalization.
Interim dividends, however, can be announced only on profits that can be distributed, and they must fulfil the same requirements as a final dividend.
Tax Implications of Dividend Distribution
Previously, companies paid Dividend Distribution Tax (DDT) under the Income Tax Act, 1961. However, the Finance Act, 2020, introduced a new tax policy that replaced DDT, taxing dividends in the hands of shareholders at their respective tax slabs.
As per Section 194 of the Income Tax Act, companies are required to deduct TDS (Tax Deducted at Source) on dividend payments exceeding the prescribed limit.
This new process provides greater transparency and fairness, and the taxation process aligns with the extent of shareholders’ income.
Non-Compliance Penalties
In case one company does not pay the announced dividend within 30 days, it might be subjected to:
- Interest on the delayed payment after the 31st.
- Section 127 fines and imprisonment of up to 2 years or a fine of up to Rs. 1,000 per day as long as the default persists.
But the penalty is not applicable in cases of delay due to legal restraints, shareholder wrangles, or causes beyond the company’s control.
Conclusion
Dividend distribution by a domestic company under the Companies Act, 2013, is a corporate process undertaken to ensure financial discipline, fairness, and transparency. By meeting the statutory terms, schedules, and reporting standards, firms not only ensure that they do not go wrong but also build investor confidence.
A reliable dividend policy is an indication of good governance and sound corporate behaviour, fundamental principles for a company that hopes to maintain its success even in a business climate full of competition.
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