Understanding Dividend Declarations and Payments

Dividends are an important indicator of the financial health of a company. It also reflects the commitment of the company to its investors. The Companies Act of 2013 provides clear guidelines for declaring and paying dividends. Chapter VIII of the Companies Act, 2013 contains sections 123 to 127, which specify these provisions. 

Declaration of Dividend

Section 123 of the Companies Act, 2013 is the cornerstone for dividend declarations. It mandates that companies can only declare dividends from earned profits. This provision ensures the responsible distribution of dividends without compromising the company's financial stability.

Key points in Section 123:

• From Current or Previous Year Profits: Companies can declare dividends only if they have earned profits in the current financial year or from accumulated profits of the past years. This rule helps prevent companies from distributing funds recklessly, ensuring they remain financially sound. The profits available for distributing dividends are calculated after accounting for depreciation according to Schedule II of the Companies Act, 2013. This ensures that the company has adequately accounted for the wear and tear of its assets before distributing profits to shareholders.
• Transfer to Reserves: Although transferring profits to reserves before declaring dividends is not mandatory, companies have the discretion to do so. This practice strengthens the company’s financial position by building up retained earnings for future growth initiatives. There are no restrictions on this, and it is at the discretion of the company to decide how much to transfer to the reserves.
• Not to distribute notional or unrealized gains: A company cannot distribute from the reserves built up by recognition of unrealized gains or revaluation of assets. This restriction makes sure that the company distributes dividends only from actual profits.
• Interim Dividend: Companies can also distribute interim dividends from the profits of the current year earned until the end of the last quarter. In case of a loss in the current year until the end of the last quarter, they can use previous year earnings, but the rate of dividend shall not exceed the average rate of dividend for the last three previous financial years.
• Inadequate Profits and Average of the Last 3 Years: If a company has inadequate profits, it can declare dividends out of the accumulated profits earned in previous years. However, the rate of dividend declared should not exceed the average of the rates declared in the preceding three financial years. This ensures that the dividends are sustainable and do not strain the company's finances.
• Government Funds: Out of money provided by the Central Government or a State Government for the payment of dividends by the company in pursuance of a guarantee given by the Government.

Example
For instance, if a company like XYZ Ltd. earned profits in the previous three years and transferred a portion of these profits to its reserves, it can declare dividends even if the current year's profits are inadequate, provided the dividend rate does not exceed the average of the last three years.

Rules Governing Dividend Declarations for the Year in which the Company is in Loss

The Companies (Declaration and Payment of Dividend) Rules, 2014 provide specific guidelines to ensure transparency and fairness in dividend distributions in case the company is at a loss in any financial year in which it proposes to make dividend payments. It has to make sure:

• Average Rate of Dividends: The rate of dividend declared should not exceed the average of rates declared in the preceding three financial years. This rule helps prevent sudden fluctuations in dividend payments and ensures consistency. [Not applicable if there is no dividend in any of those years.]
• Withdrawal Limitation: Companies are restricted from withdrawing more than 1/10th of their paid-up share capital and free reserves combined for dividend payments. This safeguards the company’s capital structure and reserves, ensuring financial stability. The amount withdrawn from reserves shall first be utilized to set off the losses incurred in the financial year in which a dividend is declared before any dividend in respect of equity shares is declared.
• Maintenance of Reserves: After declaring dividends, companies must ensure that their reserves do not fall below 15% of the paid-up share capital, as per the latest audited financial statement. This requirement ensures that companies maintain a sufficient financial cushion for future contingencies.

Example
Imagine ABC Corp. had inadequate profits in the current year but wants to declare dividends. It can do so using profits from previous years, but the total amount withdrawn should not exceed 1/10th of its paid-up share capital and free reserves, ensuring it maintains a healthy financial cushion. Also, the reserves after the dividend should not fall below 15% of the paid-up share capital.

Restrictions on Declaring Dividends

Further, the Companies Act and the rules made thereunder prohibit the distribution of dividends under the following conditions:

• Default in Repayment of Deposits or Interest: If a company has defaulted in repaying deposits or interest thereon, it cannot declare dividends.
• Default in the redemption of preference shares or the creation of a capital redemption reserve: Companies that have defaulted in the redemption of preference shares or have not created an adequate capital redemption reserve cannot distribute dividends.
• Default in Repayment of Loans or Interest: Companies that have defaulted in repaying any term loan or interest thereon to a financial institution or bank are prohibited from declaring dividends.
• Default in payment of dividends: A company cannot declare new dividends unless it has paid the earlier declared dividends.

These restrictions ensure that companies prioritize their financial obligations before distributing profits to shareholders. Companies in default of sections 73 and 74 related to the prohibition on accepting public money cannot declare any dividends until they are no longer in violation of the said sections. These restrictions make sure that the companies declare dividends only after meeting their financial obligations to other stakeholders before paying them to the equity holders.

Example
If DEF Ltd. has defaulted on a loan repayment, it must rectify this default before it can declare any dividends, ensuring that financial obligations are prioritized over shareholder payments.

Procedure for Dividend Payment

Once dividends are declared, including interim dividends, Section 123(4) mandates that the amount must be deposited in a scheduled bank within five days from the date of declaration. This prompt payment ensures that shareholders receive their dues in a timely manner, enhancing investor confidence in the company.

Example
When GHI Industries declares dividends, it must ensure the amount is deposited in a scheduled bank within five days, ensuring timely payment to its shareholders and maintaining trust.

To maintain integrity and fairness in dividend distributions, Section 123(5) specifies that dividends must be payable in cash. They can be paid by check, warrant, or electronically to registered shareholders or their bankers. Moreover, Section 123(6) prohibits companies from declaring dividends on equity shares if they fail to comply with specific provisions of the Companies Act, such as Sections 73 and 74 regarding acceptance and repayment of deposits.

Unpaid Dividend Account – Section 124

Every company must pay declared dividends within 30 days. If dividends are not paid or remain unclaimed, the company must transfer the funds to a special account in a scheduled bank, known as the unpaid dividend account, within 7 days. Within 90 days of this transfer, the company must publish a list of shareholders and their unpaid amounts on its website or a government-mandated platform. Failure to transfer funds on time incurs a 12% per-year interest penalty, distributed among shareholders based on their unpaid amounts. Shareholders can claim dividends from the unpaid dividend account within 7 years, after which the funds are transferred to the Investor Education and Protection Fund (IEPF).

If the company fails to comply with Section 124, it faces penalties of up to 1 lakh and 500 rupees per day, capped at a maximum of 10 lakhs. Additionally, officers in default may be fined 25,000 rupees and 100 rupees per day until compliance, with a maximum penalty of 2 lakhs.

Example
JKL Enterprises must ensure unpaid dividends are transferred to a special account within the stipulated time. If it fails to do so, it faces penalties and must pay interest, reinforcing the importance of compliance.

Unclaimed Dividends and IEPF Account

Section 125 of the Companies Act, 2013 mandates that any unpaid or unclaimed dividends for a continuous period of seven years from the due date shall be transferred by the company to the Investor Education and Protection Fund (IEPF) established by the central government. The IEPF is utilized for promoting investor awareness and protecting the interests of investors. The shares on which the dividend remains unclaimed for 7 years shall also be transferred to the IEPF account. Any claimant can directly claim back such shares and unpaid amounts from IEPF.

Investor Education and Protection Fund (IEPF)

The IEPF is a significant measure to protect the interests of investors. When companies transfer unclaimed dividends to the IEPF, it ensures that these funds are utilized for educating investors about their rights and responsibilities. It also safeguards the funds from being misappropriated or lying idle.

Claiming Dividends from IEPF

Shareholders whose dividends have been transferred to the IEPF can claim their dues by filing an application in the prescribed form with the IEPF Authority. This process ensures that even if dividends are unclaimed for a long period, shareholders have a mechanism to recover their entitlements.

Example
Shareholders of STU Ltd. can reclaim their unclaimed dividends from the IEPF by filing the appropriate application, ensuring their entitlements are protected even after being unclaimed for a long time.

Penalties

Non-compliance with the provisions of dividend declaration and payment can lead to severe penalties under the Companies Act, 2013. Here are some key points:

• Timely Declaration and Payment: Dividends must be declared and paid within a stipulated time frame. Failure to comply with this can result in penalties for the company and its directors.
• Penalty for Default: If a company fails to comply with the provisions of Sections 123 to 127, it can face a penalty. The company may be fined, and officers in default can be punished with imprisonment, a fine, or both.

Section 127

This section specifically deals with the punishment for failure to distribute dividends. If a company fails to pay the dividend within 30 days from the date of declaration, every director who is knowingly a party to the default shall be punishable with imprisonment for a term that may extend to two years and with a fine that shall not be less than Rs. 1,000 for every day during which such default continues. Additionally, the company shall be liable to pay simple interest at the rate of 18% per annum during the period for which such default continues. [Note: For Nidhi companies, if the amount per member is less than 100 rupees, they shall be in compliance with Section 127 if they publish it in any one local newspaper and place it on their notice board for 3 months.]

Conclusion

The Companies Act of 2013 provides a robust framework for dividend declaration and payment, aimed at protecting shareholder interests while promoting financial prudence among companies. By adhering to these regulations, companies can ensure transparency, maintain compliance, and foster trust with their investors.

Understanding these provisions is crucial for investors and corporate stakeholders alike as they navigate the landscape of corporate governance and financial management. By following these guidelines, companies can maintain a balanced approach to rewarding shareholders while sustaining their long-term growth and stability.

For further details on legal references and in-depth reading, please refer to the Companies Act, 2013, and relevant rules and amendments. This comprehensive framework ensures that dividend declarations and payments are conducted responsibly, protecting both the financial health of the company and the interests of its shareholders.