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DIVIDEND AND BONUS SHARES DIVIDENDS Dividend refers to that portion of the profits of a company which is allocated to the holders of shares by a formal declaration in the annual general meeting of the company. In other words, it refers to the return on shares held by a shareholder. Every company enjoys and inherent power to declare and distribute dividend. Such a power need not expressly be sanctioned by the memorandum or the articles of the company though the articles may regulate the manner in which dividends are to be distributed. Every company is required to obtain the consent of the general meeting before declaring and distributing dividend at a particular rate. But a company is not bound to declare dividends, if it has made no profits or has none of the profits available for distribution to shareholders. If the directors decide not to declare dividend, the members cannot challenge it. But they may seek appropriate change in the board to signify their disapproval of the board‟s action. Lord Justice observes. Dividend presupposes profits of some sort, and this is unquestionably true. But the word profits is by no means free from ambiguity. The law is much more accurately expressed by saying that dividend cannot be paid out of capital than by saying that they can only be paid out of profits. Thus, the payment of dividend is governed by two fundamental principles, namely 1) 2) That dividend must not be paid out of capital. That it must be paid only out of profits. Dividends Not to be Paid Out of Capital Payment of dividends out of capital will result in unlawful return of capital to shareholders. Thus would ultimately lead to unauthorized reduction of share capital. Any payment of dividends out of capital will make the direction liable for having committed a breach of trust and the directors may be required to replace such an amount. In flitcorfot‟s case the directors showed certain bad debts as assets in company‟s account books so as to create fictious profits which were profits which were used to pay dividends. Held, the directors had committed breach of trust and were, therefore, liable to replace the amount so paid with interest. Where however the shareholders received dividends with the knowledge that they were paid out of capital, they may be required to return the amount so received to the company. Dividend Only Out of Profits Dividends are required to be paid out of profits only. But the Act does not define the term „profits‟. There is nothing at all in the Act about how dividends are to be paid, nor how profits are to be reckoned. However, Sec.349 provides for mode of determination of profits for the limited purpose of computing managerial remuneration. Lord Justice Fletcher Moulton in Re Spanish Prospecting Company Ltd. has defined profits in the following words. Profit implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dated. If the total assets of the business at the dates be compared, the increase which they show at the later date as compared with the earlier date (due allowance, of course, being made for any capital introduce into or taken out of business in the meanwhile) represents in strictness the profits of the business during the period in question. Rules relating to Payment of Dividends 1. Payment of Dividend in Proportion to Amount Paid up A company may, if so authorised by its articles, pay dividends in proportion to the amount paid up on each share where a larger amount is paid up on some shares than on others. But if the articles do not contain any such provision, dividend will have to be paid only in proportion to the nominal value of shares. 2. Dividends to be Paid only Out of Profits No dividend shall be declared or paid by a company except of the profits of the company such dividends may be paid out of: (i) (ii) (iii) The profits of the year for which the dividends are to be paid. Out of the undistributed profits of the previous year Out of the moneys provided by the Central Government or State Government for payment of dividend in pursuance of a guarantee given by that Government.(Sec.205(1)). Provision for Depreciation But a company before declaring or paying dividend for any financial year must provide for depreciation at an appropriate rate on the assets of the company. If a company has failed to provide for depreciation for any previous financial year, it must deduct such depreciation out of profits before declaring dividend(Sec.205(1) Proviso (a)). Similarly. If the company has incurred any loss in any previous financial year, the amount of loss must be set off against the profits of any subsequent year before payment of dividends. (Sec.205(1) Proviso(b)). But the above stated arrears of depreciation or loss incurred is not required to be deducted from profits if it relates to any financial before 1960. However, the Central Government may, if it thinks necessary so to do in the public interest, waive the requirement of providing for depreciation before the declaration of dividend (Sec.205(1) Proviso(c)). Depreciation shall be provided either a) To the extent specified in Sec.350, i.e, the amount of depreciation should be calculated with reference to the written down value of the asses as shown by the books of the company at the rate specified for the assets by the Indian Income Tax Act, 1961, and the rules made thereunder, or b) In respect of each item of depreciable asset, by dividing 95 per cent of the original cost by the specified period in respect of such asset. Specified period means the number of years at the end of which at least 95 per cent of the original cost of asset will stand provided by way of depreciation, or c) On any other basis approved by the Central Government so as to reduce each depreciable asset by 95 per cent of its original cost to the company on the expiry of the specified period, or d) As regards any other depreciable asset in respect of which no rate of depreciation has been provided by this Act or the rules made thereunder, on such basis as may be approved by the Central Government (Sec.205(2)). When an asset is sold, discarded, demolished or destroyed before being depreciate in full, the excess, if any, of the written down value of such asset over its sale proceed shall be written off in the financial year in which the asset is sold, discarded, demolished or destroyed (Sections 205(2) and 350). 3. Transfer to Reserves According to Sec.205(2A), no company shall declare or pay dividends for any financial year out of the profits of the company for that year unless a certain percentage of profits as prescribed by the Central Government not exceeding ten per cent has been transferred to the reserves of the company. This has been done with a view to enable the company to plough back profits and use them for expansion of the activities of the company. It would also help the company to declare dividends in a lean year. However, a company may voluntarily transfer a higher percentage of its profits to reserve in accordance with such rules as may be made by the Central Government in this behalf. The Companies (Transfer of Profits to Reserves) Rules 1975 in accordance with the provisions of Sec.205(-a), the Central Government has prescribed the following rules under the Companies (Transfer of Profits to Reserves) Rules 1975 amended in 1976). a) Percentage of Profits to be Transferred to Reserves Under Rule 2 a company is required to transfer a percentage of its profits to reserves, according to the rules mentioned below: (i) Where the dividend proposed exceeds 10 per cent but not 12.5 per cent of the paid up capital of the company, the amount to be transferred to the reserves shall not be less than 2.5 per cent of the current profits. (ii) Where the dividend proposed exceeds 12.5 per cent but does not exceed 15 per cent of the paid-up capital, the amount to be transferred to the reserves shall not be less than 5 per cent of the current profits. (iii) Where the dividend proposed exceeds 15 per cent but does not exceed 20 per cent of the paid-up capital, the amount to be transferred to be reserved shall not be less than 7l.5 per cent of the current profits. (iv) Where the dividend proposed exceeds 20 per cent of the paidup capital, the amount to be transferred to reserves shall not be less than 10 per cent of the current profits. b) Conditions Governing Voluntary Transfer of a Higher Percentage A company which voluntarily transfers a percentage higher than 10 per cent of its profits to its reserves shall be governed by the following rules: (i) Where a dividend is declared, a minimum distribution sufficient for the maintenance of dividend to shareholders at a rate equal to the average of the rates at which dividends declared by it over the three years immediately preceding the financial year is ensured. However, where the net profits after tax are lower by 20 per cent or more than the average net profits after tax of the two financial year immediately proceeding, it shall not be necessary to ensure such minimum distribution. (ii) Where no dividend is declared, the amount proposed to be transferred to its reserves from the current profits shall be lower than the average amount of the dividends to the shareholders declared by it over the three years immediately preceding the financial year. The above rules do not apply to a newly incorporated company. Such a company is prohibited to transfer more than 10 per cent of the profits to reserves for the initial three years. 4. A company which fails to redeem its redeemable preference shares in accordance with Sec.80 A of the Act, can not declare any dividends on its equity shares so long the default continues. 5. No dividend shall be payable except in cash. But his shall not in any way affect the company‟s right to capitalize its profits or reserves for purposes of issuing fully paid-up bonus shares or paying up any amount being unpaid for the time on any shares held by the members of the company (Se.205(3)). 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. In case of shares held jointly it may be sent to the registered address of the joint shareholder named first on the register of members, or to such person and to such address as the shareholder or the joint shareholders may in writing direct (Sec.205(5)(b)). 6. Dividend is to be paid only to the registered holder of shares or to his order or to his banker. In the case of share warrants dividend is payable to the bearer of such warrant or to his bankers (Sec.205). 7. The dividend declared must be paid or the dividend warrant must be posted within 30 days of its declaration and the same shall be used for payment of dividend. 8. The dividend must be paid or the warrant must be posted within 30 days of the declaration of the dividend by the company. If a company fails to pay or post of the declaration of the dividend by the company. If a company fails t pay or post the dividend warrant within the stipulated period of 30 days, every director who is knowingly a party to such default shall be punishable with imprisonment upto 3 years (as against 7 days earier) and also a fine of Rs.1,000 for everyday during which such default continues. Moreover, the company shall be liable to pay simple interest @ 18% per annum for the period of default (Sec.207). But no offence shall be deemed to have been committed: a) Where the dividend could not be paid by reason of the operation of any law. b) Where a shareholder has given direction to the company regarding the payment of the dividend and those directions cannot be complied with. c) Where there is a dispute regarding the right to receive any d dividend. d) Where the dividend has been lawfully adjusted by the company against any sum due to it from the shareholder. e) Where for any other reason, the failure to ay the dividend or to post the warrant within the period aforesaid was not to any default on the part of the company (Sec.207). It may be noted that the above section does not make the company liable for default. It is only the officers mentioned in the section, who are in default, are punishable. A complaint for failure to pay dividend could be filed by an aggrieved shareholder only at the place of the registered office of the company and the Court having jurisdiction over that place alone could have the jurisdiction to entertain the complaint. 9. Unpaid dividend to be transferred to special dividend account (Sec.205A) where dividend declared has not been paid within 30 days of its declaration, the company shall within 7 days of the expiry of the above said 30 days transfer such unclaimed/unpaid dividend to a special account called unpaid dividend account. Default in Transferring unpaid/unclaimed dividend (Sec.205A(4). If unpaid/unclaimed dividend is not transferred to unpaid dividend account within the stipulated period on such an amount shall ensure to the benefit of the members of the company in proportion to the amount remaining unpaid to them. Payment of unclaimed/unpaid dividends (Sec.205B). Any person claiming to be entitled to any money transferred to the unpaid/unclaimed dividend account may make an application to the Central Government for an order for payment of money claimed after taking such security from him as it may think fit. Investor Education & Protection Fund (Sec.205C) It any amount transferred to unpaid dividend account remains unpaid for seven years, it shall be transferred by the company to the Investor Education and Protection Fund. (Vide Companies (Amendment) Act, 1999). The Fund shall be used for promotion of investors awareness and protection of interests of investors in accordance with such rules as may be prescribed. The Central Government shall by notification in the Official Gazette, constitute a committee to administer the Fund, and maintain separate accounts and other relevant records in relation to the Fund in such form as may be prescribed in consultation with the Comptroller and Auditor General of India. The Committee shall be entitled to spend money out of the fund for carrying out the objectives of the fund. The following unclaimed / unpaid amounts shall be transferred to the fund: a) b) c) d) e) Unpaid Dividend Matured Deposits with companies Refund of application money Matured debentures with the companies Interest accrued on the amounts referred to in clauses (a) to (d) above. f) Grants and donations given to the fund by Central Government, State Government, Companies or any other institution. g) The interest or other income received out of instruments made from the fund. 10. In the event of inadequate or no profits in any year, a company may declare dividends out of accumulated profits earned by it in any previous years and transferred to reserves. But such declaration of dividend out of reserves could be made only in accordance with the rules to be prescribed by the Central Government or in special cases with the permission of the Central Government (Sec.205A(3). The Companies (Declaration of Dividend out of Reserves) Rules.1975, provide for declaration by companies of dividends out of accumulated profits and reserves subject to the conditions that (i) The rate of dividend declared shall not exceed the average of the rates at which dividend was declared by it in the five years immediately preceding that year or 10 per cent of its paid up capital whichever is less. (ii) The total amount to be drawn from the accumulated profits earned in previous years and transferred to the reserves shall not exceed an amount equal to one tenth of the sum of its paid-up capital and free reserves and the amount so drawn shall first be utilized to set off the losses incurred in the financial year before any dividend in respect of preference or equity shares is declared. (iii) The balance of reserves after such withdrawal shall not fall below 15 percent of its paid-up capital. Explanation for purposes of this rule, profits earned by a company in previous years and transferred to reserves shall mean the total amount of net profits after tax, transferred to reserves as at the beginning of the year for which the dividend is to be declared; and in computing the said amount, the appropriations out of the amount transferred from the Development Rebate Reserve (at the expiry of the period specified under the Income Tax Act, 1961)) shall be included and all items of capital reserves including reserves created by revaluation of assets shall be excluded. 11. Payment of Dividends out of Capital Profits: Profits which arise otherwise than in the normal course of business, e.g. profits from sale of a fixed asset, are called capital profits. A company may distribute dividend out of capital profits provided. (a) (b) It is realised in cash It exists after revaluation of all the assets and liabilities. (c) The memorandum and the articles permit its distribution amongst shareholders. However, if the articles require a company to pay dividends only out of its trading profits or where the memorandum provides that capital profits can be used in writing down good will or be transferred to a reserve not available for dividend, it will prohibit a company from distributing its capital profit. But a capital profit resulting from reissue of forfeited shares cannot be distributed as dividend, because it is required to be transferred to capital reserve. 12. A company usually declare dividend at its annual general meeting. But it may declare dividend at any other general meeting (Regulation 85 Table „A”) unless the articles provide otherwise. A company cannot declare a further dividend after having declared for past years in respect of which the accounts have been closed at previous annual general meetings. 13. The company in a general meeting may declare dividends, but no dividend shall exceed the amount recommended by the board. Though the general meeting has been given the power to declare the dividend, it is not empowered to increase the amount recommended by the directors. If the directors decide not to clear any dividend, the shareholders in general meeting cannot themselves declare it. But the above will not hold good if the articles provide otherwise. Payment of Declared Dividend Once a dividend is declared it becomes a debt due from the company to its shareholders who may sue the company for its recovery after expiry of the period prescribed by Sec.207. But if a company goes into liquidation, a declared unpaid dividend will not rank with other debts due to creditors. It will only be taken into account for adjustment of the rights of shareholders as contributories (Sec.426(1) (g). Suit for dividend can be filed only at the place where the registered office of the company is situated. Preference shareholders are entitled to claim the arrears of dividends on the winding up of the company even when the dividends were never declared on such shares. But a declaration of a dividend subject to a condition precedent like subject to remittances from Pakistan is not a declaration at all as such a declaration will not allow the shareholder to sue the company until the condition is fulfilled and therefore, does not create an immediately payable debt. Where the directors merely recommended a particular rate of dividend that by itself cannot have any effect unless approved by the general meeting. But shareholders cannot increase the dividends approved by the Board of Directors though they may reduce it or reject it. Revocation of Declared Dividend Dividends once declared cannot by revoked except with the consent of the shareholders. But the board of directors may revoke it where it has been declared illegally or where due to certain compelling circumstances such as fire destroying company‟s property, or the outbreak of a war, or the imposition of a new killing tax burden, it has become necessary to conserve the remaining assets of the company. INTERIM DIVIDEND Where the directors bonafide believe that the company will have sufficient profits available for dividends at the end of the year, they may distribute apart of the profits already in hand amongst its shareholders as a part payment on account. Payment so made on account of the whole dividend for the year is known as interim dividend. It is declared between the two annual general meetings. If authorised by articles, the directors of a company may pay interim dividend. Regulation 86 of Table „A‟ provides that “the Board may from time to time pay to the members such interim dividends as appear to it to be justified by the profits of the company”. Thus, there is no limit on the number of interim dividends a company may declare in a year. The payment of interim dividend does not required the approval of the general meeting since members have no say in the matter of such dividends. Companies (Amendment) Act, 2000 on Interim Dividends The term dividend now includes interim dividend also. All provisions of the Companies Act which apply to dividends have now become applicable to interim dividends also. The newly amended section 205 requires that the amount of dividend including interim dividend shall be deposited on a separate bank account within 5 days of the declaration of such dividend. However, a company cannot declare any interim dividend unless: a) b) c) It has made provision for depreciation for the whole of the year. It has made prior adjustment of any accumulated losses. It has transferred to reserves the prescribed percentage of the profits as required under Sec.205(2A). Interim dividend like final dividend shall constitute a debt once it is declared and shall not be recoverable. Therefore, before declaring an interim dividend, the directors must satisfy themselves that the financial position of the company warrants the payment of such dividend out of its distributable profits because “the declaration of interim dividends depends much more upon estimates and opinions than the declaration of final dividends which is made upon the information contained in a formal balance sheet. Right to Dividend on Transfer of Shares In case shares are transferred near or at the time of declaration of dividend, the transferee gets entitled to received dividend if the transfer is made cum-dividend. But on an ex-dividend transfer, the transferor shall have the right to dividends. If however, there is no agreement as to dividends, the buyer is entitled to all dividends declared after the date of purchase on the other hand, the seller shall have the right to all dividends declared before the sale of the shares, although payable on dates after the date of sale of shares. It may however, be noted that a company is bound to pay dividends only to registered members. Any private arrangement between parties as to whom dividends will payable, is of no consequence to company. Bonus Shares When a company instead of paying dividend in cash decides to issue fully paid shares against such dividend to the existing shareholders, such shares are termed as bonus shares. Bonus shares are not to be issued as a gift, for shares cannot be issued without consideration. Such an issue can be better described by way of capitalization it involves capitalization of profits. They are called bonus shares because shareholders usually make no payment for such. Rules Relating to Bonus issue 1) The issue must be authorised by the articles of the company. If the articles do not have such a provision, the company should provide for it by passing a resolution at its general meeting. 2) 3) The company must have sufficient undistributed profits. Bonus can be issued only if the resolution passed by the board of directors has been approved by the shareholders in the general meeting of the company. 4) A return of the bonus issue stating the number with the Registrar within 30 days of the allotment of such shares. A company may, however, issue bonus shares out of funds not otherwise a) b) available for distribution as dividends among the shareholders in the following two cases. Out of the securities premium account of the company under Sec.78(2). Out of the capital redemption reserve account under Sec.80(5). A bonus issue is not subject to income tax since it is not treated as an income in the hands of the recipient shareholder. The issue of such shares does not entail a release by the company its shareholders of all or any art of its assets (Sec.2(22) of the Income Tax Act, 1961). In case redeemable preference shares are issued as bonus shares, the payment by the company on their redemption would involve release of some of the company‟s assets and would therefore, be subject to tax (Shashibala Navnitlal v. C.I.T. (1964), 54 i.T.R.478). 5. Under clause 22 of the listing agreement the company must intimate the stock exchange by letter or by telegram details of any increase of capital through the issue of bonus shares or rights shares immediately after the board of directors have taken a decision to that effect. SEBI GUIDELINES ON ISSUE OF BONUS SHARES 1. These guidelines are applicable only to listed public companies who shall forward to SEBI a certificate duly signed by the issuer and counter signed by its statutory auditor or by a company secretary in practice stating that the terms and conditions for the issue of bonus shares as laid down in these guidelines have been complied. 2. No bonus issue shall be made within 12months of public / right (Restriction of time lag between two bonus issues has been withdrawn). 3. Issue of bonus shares after any public/right issue is subject to the condition that no bonus issue shall be made which will dilute the value or rights of the holders of debentures, convertible fully partly. Thus, no company shall, pending conversion of FCDs/PCDs issue any shares by way of bonus unless similar benefit is extended to the holders of such FCDs /PCDs through reservation of shares in proportion to suh convertible part of FCDs/PCDs. The shares so reserved may be issued at the time of conversion(s) of such debentures on the same terms on which the bonus were made. 4. The bonus issue is made out of free reserves built out of the genuine profits or share premium collected in cash only. Infact debenture redemption reserve shall be considered as general reserve while proposing a bonus issue (Vide SEBI guidelines on debentures). 5. 6. Reserves created by revaluation of fixed assets are not capitalized. A company can not make a bonus issue in lieu of dividends. 7. No bonus issue can be made unless the existing partly paid shares are made fully paid up. 8. A company which announces its bonus issue after the approval of the board of directors must implement the proposal with in six months of the date of such approval, and shall not have the option o changing the decision. 9. A company defaulting on the payment of interest and principal in respect of fixed deposit and debentures and failing to ay the statutory dues like contribution to provident fund, gratuity, bonus, etc is prohibited to issue bonus shares. 10. With the issue of bonus shares if the subscribed and paid up capital exceeds the authorised share capital, a resolution must be passed by the company in its general body meeting for increasing the authorised capital.
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