Legal Provisions Regarding the Payment of Dividend are given below:
1. Declaration of Dividend:
Dividend for a financial year may be declared only when the Balance-sheet and Profit and loss account of the company are presented to the shareholders at the annual general meeting. It is the prerogative of the board of directors to recommend the rate of dividend to be distributed. The members have the right to approve or lower the same.
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But in no case shareholders can increase the amount. Usually, dividend is declared at the annual general meeting. But a company which has not declared dividend at an annual general meeting may do so at a subsequent general meeting. A company which has declared dividend at a general meeting is not permitted to declare dividend for the second time in that year.
2. Dividend to be Paid out of Profits:
As per Section 205, dividend by a company for any financial year can be paid or declared only out of:
(a) Profits of the company of that year arrived at after providing for depreciation in accordance with the provisions of the Act, or
(b) Profits of the company for any previous financial year or years after providing for depreciation as per the provisions of the Act, or
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(c) Out of both, or
(d) Money provided by the Central or State Governments for the payment of dividends in pursuance of the guarantee given by that Government.
3. Provision for Depreciation:
Before any dividend can be paid out of profits of any financial year, a company is required to provide depreciation:
(a) To the extent specified in Section 350; or
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(b) The amount arrived at by dividing 95% of the original cost by the specified period in respect of each depreciable asset; or
(c) On any other basis approved by the Central Government; or
(d) On the basis of rules laid down by the Central Government for those depreciable assets for which rates of deprivation has not been laid down.
4. Transfer of Profits to Reserves:
Dividend can be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation and after transfer to the reserves of the company the percentage of its profits for that year as prescribed by the Companies (Transfer of Profits to Reserve) Rules, 1975.
A company may transfer voluntarily more than 10% of its profits to reserves provided it distributes to the shareholders dividend at a rate which is not less than average dividend rate of the last three years’ dividends.
Where, however, the net profits after tax are lower by 20% or more than the average net profits after tax of the last two financial years, it will not be necessary to ensure such minimum distribution.
And where no dividend is declared in respect of a financial year, the amount proposed to be transferred to the reserves should be lower than the average amount of the dividends declared during the last three years.
However, these rules are not applicable to voluntary transfer of profits to reserves not exceeding 10%. These are also not applicable to newly incorporated companies. Such companies cannot transfer more than 10% of their profits to reserves for die initial three years.
5. Payment of Dividend out of the Reserve Funds:
A company can pay dividend out of its ‘reserve funds’ created out of the profits of the company for any previous financial year or years arrived at after providing for depreciation as required and remaining undistributed. This source can be used subject to the restrictions contained in the Companies (Declaration of Dividend out of Reserves) Rules, 1975.
(i) The rate of dividend declared shall not exceed the average of the rates at which the dividend was declared by the company in the 5 years immediately preceding that year or 10% of its paid-up capital, whichever is less.
(ii) The total amount to be drawn from the accumulated profits earned in the previous years and transferred to the reserves shall not exceed an amount equal to 1/10 of the sum of its paid-up capital and free reserves.
(iii) The amount so drawn shall be first utilised to set off the losses incurred in the financial year before declaration of any dividend in respect of preference or equity shares.
(iv) The balance of reserves after such withdrawal shall not fall below 15% of its paid-up share capital.
6. Payment of Dividend out of Capital Profits:
Profit arising out of the sale or revaluation of capital assets is termed as capital profit. Capital profits may be utilised for the purposes of declaration of dividend provided:
(a) These have been realised in cash,
(b) These remain as profits after revaluation of all the assets and liabilities, and
(c) There is nothing in the Articles of Association of the company prohibiting their distribution amongst the shareholders in the shape of cash dividends.