Appendix: Legal and Tax Aspects of Dividend Payments in India The payment of dividends in India is governed by Section 205

of the Companies Act 1956. The key requirements of the Companies Act 1956 are summarized below: Companies Act 1956 Procedure Dividend can be paid by a company for any financial year only out of the profits of the company for that year arrived at after providing for depreciation or out of the profits of the company for any previous financial year or years and remaining undistributed or out of both or out of moneys provided by the Central or a State Government for the payment of the dividend in pursuance of a guarantee given by such Government. Dividend declared by a company must be paid within 30 days. If it remains unpaid or unclaimed after 30 days, the company needs to transfer the unpaid or unclaimed amount to a special account to be opened by the company in this behalf in any scheduled bank, to be called "Unpaid Dividend Account of ... Company Limited/Company (Private) Limited". If the dividend amount remains unclaimed for a period of seven years from the date of deposit, it is transferred to a separate fund known as Investor Education and Protection Fund maintained by the Central Government. Transfer to Reserve In accordance with Companies (Transfer of Profits to Reserves) Rules, 1975, a company is required to compulsory transfer a certain percentage of its profit to reserves before declaring dividend. The prescribed percentage to be transferred to reserve is set out below: Dividend Rate Exceeds 10% but not 12.5% of paid up capital Exceeds 12.5% but not 15% of paid up capital Exceeds 15% but not 20% of paid up capital Exceeds 20% of paid up capital Declaration of Dividend out of Reserves If due to inadequacy or absence of profits in any year, a company wants to declare dividend out of the accumulated profits earned by it in previous years and transferred by it to the reserves, the followings conditions as prescribed by Companies (Declaration of Dividends out of Reserves) Rules 1975 need to be followed: Transfer to reserves Not less than 2.5% of Current Profits Not less than 5% of Current profits Not less that 7.5% of current profits Not less that 10% of the current profits

i.

the rate of the 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 ten per cent of its paid-up capital, whichever is less; 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; the balance of reserves after such drawal shall not fall below fifteen per cent of its paidup share capital.

ii.

iii.

Income Tax Act, 1961 The income tax implications on dividend as per Income Tax Act 1961 are summarized below: Tax implication of Dividend As dividend is an appropriation of profit and not an expense, any dividend paid by the company is not a tax deductible expense. Further as per Section 115 O of the Income Tax Act 1961, the company is required to pay a tax on the amount of dividend paid at the prescribed rate. The dividend distribution tax at present is charged @15% of the dividend amount. Considering 7.5% surcharge and 3% education cess, the effective dividend distribution tax rate comes to 16.61% of the dividend paid. In accordance with Section 10 (34) of the Income Tax Act, 1961, any income received by way of dividend from a domestic company is tax exempt in the hands of the recipient. Tax implication of Capital Gains For the purposes of taxation, capital gain on shares is classified into long term capital gain and short term capital gain depending on the period of holding. If equity shares are sold after holding them for a period of 12 months or more, the gain arising on sales is termed as long term capital gain. If the shares are sold within 12 months of acquisition, the gain on sale will be termed as short term capital gain. In accordance with Section 10 (38) of the Income Tax Act 1961, long term capital gain arising from sale of equity shares on a stock exchange is tax exempt. Though the transaction value would attract a tax called Securities Transaction Tax (STT). The STT at present is levied @ 0.0125% of the transaction value. Section 111A of the Income tax Act provides that if equity shares are sold in a stock exchange and securities transaction tax is chargeable on such transaction, then the short term capital gain arising from such sale will be chargeable to tax @ 15%.

Apollo Tyres (Stable Dividend Rate Policy) The company is pursuing a stable dividend rate policy. The dividend rate is kept constant notwithstanding changes in the earnings. As a result the dividend payout ratio is fluctuating. There is no target dividend payout ratio.
Year 2003 2004 2005 2006 2007 2008 2009 Profit After Tax Dividend (INR Million) (INR. Million) 1200 184 704 195 674 197 782 197 1134 238 2193 295 1081 265 Dividend Payout Dividend Rate Ratio 14% 45% 25% 45% 26% 45% 22% 45% 18% 45% 12% 59% 25% 45%

Source: Annual Reports of the company

Bharat Electronics Limited The company has a target dividend payout ratio of 23%. Accordingly the dividend moves in direct proportion of earnings. For the year 2009, as PAT declined, there is proportionate decline in the dividends as well maintaining the dividend payout ratio at 23%.
Year 2003 2004 2005 2006 2007 2008 2009 Profit After Tax Dividend (INR Million) (INR. Million) 2606 632 3161 903 4464 1021 5830 1332 7189 1675 8267 1937 7458 1750 Dividend Payout Dividend Rate Ratio 24% 70% 29% 100% 23% 112% 23% 146% 23% 180% 23% 207% 23% 187%

Source: Authors calculations based upon data obtained from the Annual Reports of the company for the respective years

Case: Dividend Policy of Hero Honda Motors Limited Hero Honda Motors, the country's top two-wheeler maker, declared a dividend of 4,000 per cent. The company's board of directors at a meeting considered and declared a Silver Jubilee Special Dividend of 4,000 per cent or INR 80 per equity share of INR 2 each, Hero Honda said in a filing to the Bombay Stock Exchange. (The Economic Times, 30th March 2010). Hero Honda Motors Limited (HHML) is the largest manufacturer of motorcycles in India. The company was incorporated in the year 1984 as a joint venture between Hero Group of India and Honda Motors of Japan. In less than two decades it became the Worlds largest two wheelers manufacturing company. The company earned a net profit of INR 12,818 Million during the year 2008-09 compared to INR 9,679 Million in the previous year. The Board of Directors of the company recommended dividend @ 1000% on the paid up capital of INR 399 Million for the year 2008-09. `Over the years, the company has consistently followed a policy of paying high dividends, keeping in mind the cash-generating capacities, the expected capital needs of the business and strategic considerations.(Annual Report 2008-09). In the letter to the shareholders the Chairman of the company stated We are very much aware of your unstinted support all along for this organization and its efforts, which are directed at creating wealth and profit. We do not believe in holding the surplus beyond requirement and thus have been distributing them in the form of dividend. We are happy that we have been able to declare every year an increasing rate of dividend for our shareholders (Annual Report 2003-04). The dividend policy of the company has two distinct phases one up-to the year 2000-01 and the second from 2001-02 onwards. The dividend rates and dividend payout ratios of the company are stated below: Year 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Dividend Rate (%) 30 32 35 40 75 100 150 850 900 1000 1000 1000 850 950 1000 Dividend Payout Ratio (%) 10 24 14 11 23 23 27 75 70 62 56 47 46 46 37

The company increased its dividend payout ratio to 75% in the year 2001-02. However the payout ratio has come down to 37% by the year 2008-09 due to increase in profitability in these years. The company is able to meet all its funding requirements from retained earnings and maintaining its zero debt status. About 55% of the share capital is held by the promoters. The company has not used buy-back as an option to return excess cash to shareholders though it did issue bonus shares in the ratio of 1:4 in the year 1994 and 1:1 in the year 1998. The company split each share of face value of INR 10 into 5 shares of face value of INR 2 each in the year 2001. The equity shares of the company closed at Rs.2,022 on 25th March 2010 at the Stock Exchange, Mumbai. The financials of the company are given in Annexure. Source: Annual Reports of the company Questions for discussions i. ii. iii. Critically evaluate the dividend policy of Hero Honda Motors Limited? Do you think buy back would be a better option for HHML than cash dividends? What is the rationale behind bonus (stock dividend) and stock split? Do they really create value for shareholders?

Annexure: Profit and Loss Account

(INR Million) 2000 22,507 200 108 22,815 19,279 3,336 3,536 309 3,227 347 34 2,846 0 2,846 925 1,921 399 44 2001 31,749 74 182 32,005 27,318 4,613 4,687 351 4,336 443 124 3,770 0 3,770 1,301 2,469 599 61 2002 44,691 749 -58 45,382 37,499 7,134 7,883 329 7,554 510 100 6,944 0 6,944 2,315 4,629 3,395 102 2003 51,036 918 211 52,164 42,341 8,905 9,823 248 9,575 580 149 8,846 0 8,846 3,038 5,808 3,594 461 2004 58,381 1,666 -216 59,832 48,140 10,025 11,692 230 11,462 733 7 10,722 3 10,725 3,441 7,283 3,994 512 2005 74,284 1,382 150 75,816 62,572 11,862 13,244 178 13,066 894 0 12,173 0 12,173 4,068 8,105 3,994 565 2006 87,192 1,605 150 88,946 73,522 13,820 15,424 156 15,269 1,146 0 14,122 0 14,122 4,409 9,713 3,994 560 2007 99,060 1,977 32 101,068 87,072 12,020 13,996 138 13,859 1,398 0 12,461 0 12,461 3,882 8,579 3,395 577 2008 103,450 2,163 -141 105,472 89,631 13,678 15,841 135 15,706 1,603 0 14,103 0 14,103 4,424 9,679 3,794 645 2009 123,254 2,221 221 125,696 105,945 17,530 19,752 130 19,621 1,807 0 17,815 0 17,815 4,997 12,818 3,994 679

Income
Net Sales Other Income Stock Adjustments Total Income Total Expenses Operating Profits PBDIT Interest PBDT Depreciation Other Written Off Profit Before Tax Extra-ordinary items PBT (Post Extra-ordinary Items) Tax Net Profit Equity Dividend Corporate Dividend Tax

Balance Sheet
(INR Million) Sources of Funds Equity Share Capital Reserves Net-worth Total Debt Total Liabilities Applications of Funds Fixed Assets Investments Net Current Assets Miscellaneous Expenses Total Assets 36,340 1,677 -459 48 4,994 43,680 2,882 -665 202 6,957 48,202 7,258 -4,245 102 8,022 49,797 11,930 -7,155 115 9,953 57,289 15,651 -8,404 0 13,135 67,857 20,267 -10,468 0 16,951 95,379 20,619 -8,603 0 21,951 118,452 19,739 -6,941 0 26,352 119,711 25,668 -10,133 0 31,182 158,576 33,688 -11,838 0 38,792 399 4,084 4,483 511 4,994 399 5,893 6,292 665 6,957 399 6,458 6,858 1,164 8,022 399 8,211 8,610 1,343 9,953 399 10,989 11,388 1,747 13,135 399 14,534 14,934 2,018 16,951 399 19,694 20,093 1,858 21,951 399 24,301 24,701 1,652 26,352 399 29,463 29,862 1,320 31,182 399 37,608 38,008 785 38,792 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Cash Flow Statement

Cash Flow Statement (INR Million) Net Profit Before Tax Net Cash From Operating Activities Net Cash (used in)/from Investing Activities Net Cash (used in)/from Financing Activities Net (decrease)/increase In Cash and Cash Equivalents Opening Cash & Cash Equivalents Closing Cash & Cash Equivalents 2846 2054 -1433 -485 136 -43 93 3770 3384 -2743 -283 354 93 447 6944 6538 -4666 -1235 638 451 1089 8846 6190 -4847 -2189 -846 1090 244 10725 9729 -3764 -5836 129 243 373 12173 7468 -5629 -2035 -195 371 176 14122 9361 -3235 -4712 1414 176 1590 12461 6251 -2731 -4743 -1224 1587 363 14103 12118 -7810 -4323 -16 167 151 17815 13590 -8612 -4999 -21 152 131 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Case: Dividend payout ratio of SENSEX companies SENSEX is the oldest stock index in India. It is made up of 30 component stocks representing large, well-established and financially sound companies across key sectors. These 30 companies account for over 42% of the market capitalization and over 16% of the market turnover. The dividend payout ratio and dividend yields for these 30 companies are given below:
Dividend Payout Ratio 31.44% 5.74% 31.02% 23.76% 19.20% 43.55% 22.17% 36.46% 12.04% 76.61% 36.61% 27.03% 50.06% 15.91% 20.59% 10.74% 9.71% 42.31% 49.66% 4.02% 14.50% 16.20% 26.33% 22.90% 23.46% 34.21% 34.53% 31.13% 27.16% 23.05% Dividend Yield as on 1st April 2010 2.10% 0.66% 0.70% 0.64% 1.06% 1.08% 0.52% 1.03% 0.73% 3.25% 1.15% 0.88% 1.40% 0.65% 0.64% 1.86% 0.25% 1.73% 2.95% 0.47% 1.19% 0.69% 0.76% 1.38% 0.41% 1.73% 1.61% 0.85% 2.45% 0.55%

Company

ACC BHARTI AIRTEL BHEL DLF GRASIM INDUSTRIES HDFC HDFC BANK HERO HONDA MOTORS HINDALCO INDUSTRIES HINDUSTAN UNILEVER ICICI BANK INFOSYS TECHNOLOGIES ITC JAIPRAKASH ASSOCIATES LARSEN & TOUBRO MAHINDRA & MAHINDRA MARUTI SUZUKI NTPC ONGC RELIANCE COMMUNICATIONS RELIANCE INDUSTRIES RELIANCE INFRASTRUCTURE SUN PHARMA INDUSTRIES STATE BANK OF INDIA STERLITE INDUSTRIES TATA CONSULTANCY SERVICES TATA MOTORS TATA POWER CO. TATA STEEL WIPRO

Source: Authors calculations based upon data obtained from the Annual Reports of the company for the respective years and the prices on the Bombay Stock Exchange on 1st April 2010 obtained from www.bseindia.com The dividend payout ratio has been calculated as Dividend Payout Ratio = (Equity Dividend + Tax on Dividend) (Profit After Tax less Preference Dividend)

The dividend yield is equal to dividend per share divided by the current market price. Questions for discussions: i. ii. iii. The average dividend payout for the SENSEX companies is 28%. What does it indicates? How do you explain the wide variations in the dividend payout ratios of different companies? The average dividend yield is about 1%. Do you think dividend still matters?