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DIVIDEND – CONCEPT, TYPES AND LEGAL COMPLIANCES IN INDIA
DIVIDEND – CONCEPT, TYPES AND LEGAL COMPLIANCES IN INDIA
1. Introduction
Investment in a company is primarily driven by the expectation of earning returns, and one of the most widely recognized forms of such return in the Indian corporate framework is dividend distribution. The expression “dividend” originates from the Latin term dividendum, which signifies something that is to be divided. In the corporate context, it denotes the allocation of a company’s profits among its shareholders in proportion to their shareholding. This distribution is not merely a financial transaction but a reflection of the company’s profitability, financial stability, and commitment towards rewarding its investors.
The decision to declare dividend is not mechanical in nature. It requires the management to evaluate several interconnected aspects such as the availability of profits, cash flow position, expansion strategies, and prevailing business conditions. Therefore, dividend declaration involves a balance between distributing profits and retaining earnings for future growth.
2. Meaning and Scope of Dividend
2.1 Legal Meaning
Under the Companies Act, 2013, dividend is defined in an inclusive manner to cover interim dividend as well. However, this definition does not exhaustively explain the concept, and hence, its practical interpretation becomes important.
2.2 Practical Interpretation
In essence, dividend can be understood as the portion of a company’s earnings that is distributed among its shareholders as a return on their investment. It is paid to both equity and preference shareholders, depending on the rights attached to their shares. From an investor’s perspective, a consistent dividend-paying history often indicates financial soundness and managerial efficiency, making it an important factor in investment decisions.
3. Classification of Dividend
3.1 Interim Dividend
Interim dividend refers to the amount distributed by the company during the course of a financial year or after its closure but prior to the conduct of the Annual General Meeting. This type of dividend is declared by the Board of Directors based on interim financial results. Since it does not require shareholder approval, the Board must exercise prudence, especially in situations where the company has incurred losses in the current year.
3.2 Final Dividend
Final dividend is declared after the completion of the financial year and is based on the audited financial statements of the company. Although it is recommended by the Board, it becomes payable only after approval by the shareholders at the Annual General Meeting. This ensures that shareholders have a direct say in the final appropriation of profits.
4. Nature of Dividend – Mandatory or Discretionary
Dividend declaration is not compulsory under Indian corporate law. There is no statutory requirement obligating companies to distribute profits as dividend. Even though profits belong to shareholders in an economic sense, the company retains the discretion to decide whether such profits should be distributed or retained.
Judicial pronouncements have also clarified that shareholders cannot compel a company to declare dividend. However, once a dividend is formally declared, it assumes the character of a debt, thereby creating a binding obligation on the company to pay the same within the prescribed time.
5. Preference Dividend and Shareholder Rights
Preference shareholders enjoy a preferential right to receive dividend in accordance with the terms of issue of their shares. This right, however, is conditional upon the availability of distributable profits as required under Section 123 of the Companies Act, 2013.
In cases where multiple classes of preference shares exist, the priority of payment depends on the specific terms governing each class. Where such terms are not explicitly provided, dividend is generally distributed proportionately.
A further distinction exists between cumulative and non-cumulative preference shares. In the case of cumulative shares, any unpaid dividend accumulates and becomes payable in subsequent years when sufficient profits are available. Conversely, non-cumulative preference shareholders lose their right to dividend if it is not declared in a particular year.
Additionally, participating preference shareholders may be entitled to share in surplus profits after the payment of dividend to equity shareholders, subject to the conditions attached to their shares.
6. Procedure for Declaration and Payment of Dividend
The process of dividend declaration is governed by a series of steps that ensure transparency and regulatory compliance. Initially, the Board of Directors convenes a meeting after issuing due notice and evaluates the financial position of the company. Based on this assessment, the Board either declares an interim dividend or recommends a final dividend.
In the case of final dividend, shareholder approval is obtained at the Annual General Meeting. Once declared, the company is required to transfer the dividend amount to a separate bank account within a stipulated period. Thereafter, payment must be made to eligible shareholders within thirty days from the date of declaration.
If the dividend remains unpaid or unclaimed, it is required to be transferred to a designated account known as the Unpaid Dividend Account. Any amount that continues to remain unclaimed for a period of seven years must be transferred to the Investor Education and Protection Fund along with the corresponding shares.
7. Legal Position on Revocation of Dividend
A crucial distinction exists between proposed and declared dividend. Until a dividend is declared, shareholders do not have any enforceable right to claim it. However, once it is declared, it becomes a legally enforceable obligation and cannot be withdrawn. This principle ensures certainty and safeguards the interests of shareholders.
8. Statutory Framework under the Companies Act, 2013
8.1 Conditions for Declaration
The Companies Act mandates that dividend can be declared only out of profits earned during the current financial year after accounting for depreciation, or from accumulated profits of previous years. Such accumulated profits must be in the nature of free reserves.
The law also imposes certain safeguards, such as restrictions on declaration of interim dividend in case of current losses and the requirement to deposit the declared amount in a separate bank account within a prescribed time.
8.2 Unpaid Dividend and Investor Protection
The Act provides a structured mechanism for dealing with unpaid or unclaimed dividends. Companies are required to transfer such amounts to a special account and disclose relevant details on their website. If the amount remains unclaimed for a continuous period of seven years, it must be transferred to the Investor Education and Protection Fund, thereby ensuring that such funds are utilized for investor awareness and protection.
8.3 Consequences of Non-Compliance
Failure to distribute declared dividend within the stipulated period attracts penal consequences. The company becomes liable to pay interest on the delayed amount, and responsible officers may face monetary penalties and imprisonment in certain cases.
9. Dividend out of Reserves
In situations where a company does not have sufficient profits in a particular year, it may still declare dividend out of accumulated reserves, subject to compliance with prescribed conditions. These conditions are designed to ensure that the financial stability of the company is not adversely affected and include limitations on the rate and quantum of dividend, as well as maintenance of a minimum reserve balance.
10. Regulatory Requirements for Listed Companies
Listed entities are required to comply with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, which impose additional disclosure and procedural obligations.
These include prior intimation to stock exchanges regarding Board meetings where dividend is to be considered, advance notice of record date, and disclosure of dividend on a per-share basis. Certain large listed entities are also required to formulate and disclose a dividend distribution policy, thereby enhancing transparency and investor confidence.
11. Taxation of Dividend
11.1 Shift in Tax Regime
The taxation of dividend in India underwent a significant transformation with the enactment of the Finance Act, 2020. The earlier system of Dividend Distribution Tax, wherein companies were liable to pay tax on dividends, was abolished, and the tax burden was shifted to shareholders.
11.2 Taxability and TDS
Dividend income is now taxable in the hands of shareholders under the applicable provisions of the Income Tax Act, 1961. Companies are required to deduct tax at source at specified rates, depending on the status of the shareholder and availability of Permanent Account Number (PAN). In the case of individual shareholders, tax deduction is triggered only when the dividend exceeds the prescribed threshold.
11.3 Deduction of Expenses
Shareholders are permitted to claim deduction for interest expenses incurred on borrowed funds used for investment in shares, subject to a specified limit. This ensures that only the net income is taxed.
11.4 Inclusive Scope of Dividend
The scope of dividend extends beyond routine profit distribution and includes certain deemed distributions such as payments made during liquidation, capital reduction, or loans and advances to specified shareholders out of accumulated profits.
12. Conclusion
Dividend plays a vital role in the relationship between a company and its shareholders. While it serves as a mechanism for sharing profits, it also reflects the company’s financial discipline and long-term vision. The regulatory framework governing dividends in India is comprehensive and seeks to balance the interests of shareholders with the financial stability of the company.
A well-planned dividend policy, coupled with strict compliance with legal and tax provisions, not only enhances investor confidence but also contributes to sustainable corporate growth.
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Disclaimer
Every effort has been made to ensure accuracy in this material. However, inadvertent errors or omissions may occur. Any discrepancies brought to the author’s notice will be rectified in subsequent editions. The author shall not be liable for any direct, indirect, incidental, or consequential damages arising from the use of this material. This article is based on various sources including statutory enactments, judicial decisions, academic research papers, professional journals, and publicly available legal materials.
Anshul Goel
LegalMantra.net Team