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EP CL 22 810 Difference between Dividend and Interest While dividend is paid on preference and equity shares, interest is paid

on debentures and long term and short term loans/borrowings including fixed deposits. Interest is a debt which like all debts is paid out of the companys assets generally. A dividend, however becomes a debt only after it has been declared by the company. Dividend cannot be paid out of the assets of the company, generally it can be declared only out of the profit available for the purpose. Interest is a charge on profits while dividend is an appropriation of profits. The power to pay dividend is inherent in a company and is not derived from the Companies Act, 1956 or the Memorandum or Articles of Association although the Act and the Articles generally regulate the manner in which dividends are to be declared. Right to claim dividend will only arise after a dividend is declared by the company in general meeting and until and unless it is so declared, the shareholder has no claim against the company in respect of it. The observation of the Bombay High Court in Bacha F Guzdar v. CIT (1952) 22 Comp Cases 198 (Bom) was improved upon by the Supreme Court saying that the right to participation in the profits exists independent of any declaration by the company with only difference that the enjoyment of profits is postponed until dividends are declared [ Bacha F Guzdar (Mrs.) v

. CIT (1955) 25 Com. Cases 1 at p. 6] Types of Dividend Final Dividend Final dividend is recommended by the Board of directors in its report to the shareholders, as per the requirements of Section 217 of the Companies Act, which is attached to the balance sheet for the relevant financial year. It is declared by the shareholders at the annual general meeting. Usually articles of association of companies provide that the shareholders cannot increase the rate or amount of dividend than the one recommended by the Board. The shareholders may, however, declare the payment of dividend on equity shares at a rate lower than the one recommended by the directors in their report. It is the discretion of the Board of directors to recommend or not to recommend the declaration of final dividend, which has to be exercised in good faith in the interest of the company. The shareholders have no power to declare final dividend in the absence of a recommendation of the Board of directors in this regard. Interim Dividend Section 2(14A) defines 'Dividend' to include interim dividend. The Companies (Amendment) Act, 2000 has amended Section 205 to make provisions for interim dividend. The Board of directors may declare interim dividend. The interim dividend is paid between two annual general meetings of the company. A company can normally estimate its profits for the current financial year on a fairly reasonable basis and in that event it can allocate to the reserves the prescribed percentage of profits on the basis of its estimated profits. As a measure of precaution, the company may allocate to the reserves a higher amount than the actual amount based on the prescribed percentage of its estimated profits. EP CL -

22 811 Further, it should also provide for depreciation in full. It should transfer to the reserves an amount based on estimated profits after the end of the financial years and before the finalisation of the amounts for the financial year and thereafter decide to pay an interim dividend to its shareholders. Prior to the coming into force of the Companies (Amendment) Act, 2000, the Act did not contain specific provisions for payment of interim dividend. However, if the articles of association of company authorised payment of interim dividend as per regulation 86 of the Table A of Schedule I, then the Board of directors of such company could declare an interim dividend where its profits warranted such payment. A mere resolution for declaration of an interim dividend did not create any liability and could be rescinded at any time before actual payment. This was so even if the cash to cover the proposed dividend had been placed into a separate account. The distinction between interim and final dividend was that, unlike interim dividend, a final dividend once declared by the company in general meeting was a debt and created an enforceable obligation. [ Punjab National Bank v. Union of India (1986) 59 Comp Cases 35 (Del.)] With the enactment of the Companies (Amendment) Act, 2000, this position has changed. Interim dividend stands on the same footing as that of the final dividend. Both interim and final dividend when declared become debt and are payable within 30 days of declaration. Dividend on Preference Shares A Preference share carries a preferential right as to dividend in accordance with the term of issue and the articles of association, subject to the availability of distributable profits. The preferential right to a dividend could either be a fixed amount or an amount calculated at a fixed rate. It may be cumulative or non-

cumulative. Preference shares can carry dividend of a fixed amount, before any dividend is paid on the equity shares. If there are two or more classes of preference shares, the shareholders of the class which has priority are similarly entitled to their preferential dividend before any dividend is paid in respect of the other class. But these rights in respect of dividends are subject to three conditions. Firstly, preference shares are part of the companys share capital, consequently, preference dividends can be paid only if the company has earned sufficient profits. Secondly, a dividend becomes payable to the shareholders only when it is declared in the manner laid down in the Act and by the companys articles. Thirdly, there should have been a formal declaration. Preference shareholders are not entitled to treat the preference dividend as a debt and sue for its payment in the first instance. However, if the articles specify that the companys profit shall be applied, by way of payment of the preference dividend, the preference shareholder can sue for it even though it has not been declared [ Evling v. Israel & Oppenheimer Ltd. (1918) 1 Ch. 101]. Dividend on Equity Shares Dividend on equity shares are to be paid in accordance with the rights of the respective classes of shares. Equity shareholders are entitled to be paid dividend on their shares only after all dividends on preference shares have been paid to date. Although the equity shareholder stands second in preference to preference shareholders, he enjoys a privilege of a higher dividend as the preference dividend is fixed and cannot be increased, however, large the companys profits may be, unless EP CL 22 812

the preference shares carry the right to participate in surplus profits. Therefore, except in the above mentioned situation, the whole of the residual profits of the company after paying the preference dividend may be paid out as dividend to the equity shareholders either immediately or in later years. State whether the following statement is True or False Dividend can be paid out of the assets of the company. True False Correct Answer: False Dividend cannot be paid out of the assets of the company, and generally, can be declared only out of the profit available for the purpose. 2. RESTRICTIONS ON DECLARATION OF DIVIDEND AND PURPOSE BEHIND DECLARING DIVIDEND The restriction that the company law puts on declaration of dividends by companies is that they must be paid only out of profits and after providing for depreciation. Of course, losses, if any of the previous years must be set off before declaring dividend. However, in exceptional circumstances, the Central Government has the power to exempt a company or a class of companies from the provision of providing depreciation before declaration of dividend. The purpose of imposing this restriction is to ensure that the assets of companies are preserved for the benefit of their creditors and not to be distributed among members of the companies in the guise of dividends. Sub-section (2B) has been inserted to Section 205 which provides that if a company fails to comply with the provisions of Section 80A i.e. redemption of irredeemable preference shares, it shall not declare any dividend on its equity shares so long as such failure continues. 3. ASCERTAINMENT OF DIVISIBLE PROFITS AND DIVIDENDS Divisible profits means the profits which the law allows the company to distribute

to the shareholders by way of dividend. According to Palmers Company Law, the terms divisible profits and profits in the legal sense are synonymous. The profits of a business mean the net proceeds of the concern after deducting the necessary outgoings without which those proceeds could not be earned. [ Bharat Insurance Co. Ltd. v. CIT (1931) 1 Com. Cases 192, 196 (Lah)]. Profits available for dividend has been held to mean the profits which the directors consider should be distributed after making provision for depreciation or past losses, for reserves or for other purposes. A proposal for declaration of dividend involves various considerations like the annual wo rking of the company, future prospects of the companys business, building up of adequate reserves for future expansion etc. Simply because the companys accounts disclose profits in any year, it does not follow that declaration of dividend is EP CL 22 813 a must. The concept of divisible profits is undefined and is a highly relative term. The quantum of profit, the rate of dividend previously maintained, tax liabilities, employees claim on bonus and similar other factors that are likely to claim a share in the profits have to be carefully scrutinised. Here the question that arises is as to how profits are calculated for this purpose. Under Section 205(1) of the Act dividend can be paid by a company (a) out of the profits of the company for that year after providing for depreciation

under Section 205(2); and/or (b) out of the profits of the company for the previous financial year or years arrived at after providing for depreciation under Section 205(2) and remaining undistributed; or (c) out of moneys provided by the Central or State Government for the payment of dividend pursuant to a guarantee given by the Government. Except the above, one cannot get any guidance from the Act as to how the profits are to be calculated for the purpose of payment of dividend. However, under Section 211(2) every profit and loss account of a company should give a true and fair view of the profit or loss of the company for the financial year and shall, subject, as aforesaid, comply with the requirements of Part II of Schedule VI, so far as they are applicable thereto. However, it is not compulsory to provide depreciation under Part II of Schedule VI. But, it has been mentioned in Section 205 that depreciation should be provided before dividend is declared out of profits. It should be noted that the Act provides for detailed guidelines for computation of profits for the purpose of managerial remuneration, payment of donations to charitable and other purposes not connected with the business of the company in Sections 349 and 350 of the Act. Depreciation Under Section 205(2) depreciation should be provided in any one of the following ways before arriving at the distributable profits, viz: (a) to the extent specified in Section 350; or (b) in respect of each item of depreciable asset, for such an amount as is arrived at by dividing ninety-five per cent of the original cost thereof to the company by the specified period in respect of such asset; or (c) on any other basis as approved by the Central Government which has the effect of writing off by way of depreciation ninety-five per cent of the original cost to the company of each such depreciable asset on the expiry of the specified period; or (d) in respect of any other depreciable asset where no rate of depreciation has been provided in this Act or any rules made thereunder, on such basis as is

approved by the Central Government. Section 350 of the Companies Act, 1956 [as amended vide Companies (Amendment) Act, 2000] provides that the amount of depreciation to be deducted is EP CL 22 814 the amount of depreciation on assets as shown by the books of the company at the end of the financial year at the rates specified in Schedule XIV. Schedule XIV prescribes the rates of depreciation of various assets both under Written-DownValue Method and Straight Line Method for Single Shift, Double Shift and Triple Shift basis. Under proviso to Section 350, where any asset is sold, discarded, demolished or destroyed for any reason before depreciation of such asset has been provided for in full, the excess, if any of the written down value of such asset over its sale proceeds or as the case may be, its scrap value, shall be written off in the financial year in which the asset is sold, discarded, demolished or destroyed. Section 205(5) defines specified period in respect of any depreciable asset to mean the number of years at the end of which at least ninety-five per cent of the original cost of that asset to the company would have been provided for by way of depreciation if depreciation were to be calculated in accordance with the provisions of Section 350. Provision of Depreciation Schedule XIV which was inserted by the Companies (Amendment) Act, 1988 contains the rates of depreciation for various assets. Prior to the Companies

(Amendment) Act, 1988, Companies while determining distributable profits for the purposes of declaring dividend had to provide for depreciation at the rates specified for various assets by the Income-tax Act, 1961. Clause (c) of the proviso to the Sub-section (1) of Section 205 of the Act empowers the Central Government in public interest to allow any company to declare or pay dividend for any financial year out of profits for that year or any previous financial year(s) without providing for depreciation. For obtaining approval of the Central Government, the Board of directors of a company proposing to pay dividend without providing for depreciation, should pass a resolution authorising the managing director or the company secretary to make an application to the Central Government. As stated earlier, the Companies (Amendment) Act, 2000 has amended the provisions of Section 350 to the effect that the depreciation on assets as shown by the books of the company at the rate specified in Schedule XIV may be taken into account for payment of dividend. Manner of providing depreciation According to clause (k) of Sub-section (4) of Section 349, in computing net profit for the purpose of Section 349, depreciation to the extent specified in Section 350 shall be deducted. Section 350 lays down that the amount of depreciation to be deducted in pursuance of clause (k) of Sub-section (4) of the Section 349 shall be the amount of depreciation on asset as shown by the books of the company at the end of the financial year expiring at the commencement of the Act or immediately thereafter and at the end of each subsequent financial year, at the rate specified in Schedule XIV. EP CL 22 815 Therefore, for the purposes of the Companies Act, depreciation has to be

calculated in accordance with the rates specified in Schedule XIV. In this Schedule, assets have been classified into (I) Buildings; ( II ) Plant and Machinery; ( III ) Furniture an d fittings; and ( IV ) Ships. Under each class, several items of assets have been given and for each of them or group of them, depreciation rates have been prescribed under the written down value method (WDV) and the straight line method (SLM). A company is free to adopt either of the two methods of depreciation and use appropriate rates of depreciation. In the event of adoption of the straight line method of depreciation by a company the concept of specified period has no relevance. So far as the class plant and machinery is concerned, two sets of depreciation rates, viz. General rate and special rate, have been prescribed, under each of the aforesaid methods, viz., WDV method and the SLM method. General rate is applicable in respect of items of plant and machinery and continuous process plants, which are operated 24 hours a day and are not covered by special rates. The items of plant and machinery, which are covered by special rates, have been put under four categories and for each of the said categories special rates of depreciation have been specified. Choose the correct answer Which of the following is prescribed by Schedule XIV for the rates of depreciation of various assets under the straight line method? (a) Double shift basis (b) Triple shift basis (c) Single shift basis

(d) All of the above Correct answer: d Schedule XIV prescribes the rates of depreciation of various assets both under the written down value method and straight line method for single shift, double shift and triple shift basis. Loss of previous year(s) to be set off against profits of current year or previous years. As per clause (b) of proviso to section 205(1) of the Companies Act, where a company has incurred any loss in any financial year or years falling after the commencement of the Companies (Amendment) Act, 1960, then the lower of the following two amounts, namely: (a) the amount of the loss, or (b) the amount of depreciation provided for that year or those years, Should be set off against the profits of the year for which the dividend is proposed to be declared or against the profit of the company for any previous EP CL 22 816 financial year or years arrived at after providing for depreciation under Sub-section (2) or against both. Transfer of Profits to Reserves As we have discussed earlier, under Sub-section (2A) of Section 205 no dividend can be declared by a company for any financial year except on transfer to reserve of the company of such percentage of its profits for that year as has been prescribed (maximum being 10%). On exercise of their power under this subsection the Central Government have issued the Companies (Transfer of Profits to Reserves) Rules, 1975 prescribing the percentages of profits to be transferred to

reserves before declaring dividend. Under rule 2 of the rules, the following percentages of profit will have to be transferred before a dividend is declared: Rate of dividend Amount to be transferred to Reserves (a) If the proposed dividend exceeds 10% but does Not less than 2.5% of the not exceed 12.5% of the paid-up capital current profits. (b) If the proposed dividend exceeds 12.5% but Not less than 5% of the does not exceed 15% of the paid-up capital current profits (c) If the proposed dividend exceeds 15% but Not less than 7.5% of the does not exceed 20% of the paid-up capital current profits. (d) If the proposed dividend exceeds 20% Not less than 10% of the of the paid-up capital current profits. However, if a company wishes to transfer more than 10% of profits to reserves in a year, it can do so after complying with the provisions of Rule 3 of Companies (Transfer of Profits to Reserves) Rules, 1975. The conditions as per Rule 3 are: 1. Where a dividend is declared (a) it should not be less than the average of the rates at which dividends were declared by the company for the last three years immediately preceding the financial year; or (b) where Bonus shares have either been issued in the financial year in which dividend is declared or in the three years immediately preceding the financial year, it should not be less than the average amount (quantum) of dividend declared for the last three years immediately preceding the financial year. The conditions are not applicable where the net profits after the tax are lower by 20% or more than the average net profits after tax of the two financial years immediately preceding the financial year.

2. Where no dividend is declared, the amount proposed to be transferred to the EP CL 22 817 reserves from the current profits shall be lower than the average amount of the dividends to the shareholders declared in the three years immediately preceding the financial year. A newly incorporated company is prohibited from transferring more than ten per cent of its profits to its reserves. [Circular No. 20/76 (5/10/76CL -XIV and 1/1/76-CL.VI) 26.07.1976]. The Department of Company Affairs (Now Ministry of Corporate Affairs) ha s given certain clarifications in regard to the aforementioned rules which are reproduced in Annexure I. As an incentive to increase the investment in the desired area higher rates of depreciation has to be provided under Section 205 of the Act than warranted on the basis of the effective working life of the assets resulting in diminution of profits both for distribution of dividend and for managerial remuneration. In order to remove hardship on this count the Ministry of Corporate Affairs (MCA) approves of proposals for provisions of depreciation at lower rates on such assets in order to enable companies to pay dividend to shareholders. An application will have to be made to MCA for obtaining the approval showing the profits earned before provision of depreciation and after provision of depreciation on the normal rates arrived at and the quantum of dividend proposed together with a certificate from the suppliers of

machinery or approved valuers about the normal working life of asset. Dividend in Case of Absence or Inadequacy of Profits In case of absence or inadequacy of profits, dividend can be declared under Section 205A(3) of the Act out of the accumulated profits earned by the company in the previous years and transferred by it to reserves. Such declaration should be in accordance with the rules prescribed in this regard by the Government. If such a declaration does not conform to the rules, the declaration of dividend will require the previous approval of the Central Government. In exercise of its powers under this sub-section, the Central Government has framed rules known as Companies (Declaration of Dividend Out of Reserves) Rules, 1975. Under these rules dividend can be declared from amounts drawn from reserves (i.e. free reserves only and not from any specific reserves) in case of absence or or inadequacy of profits in any year subject to the following conditions: (a) the rate of dividend declared shall not exceed the average of the rates of dividend declared by it during the immediately preceding last five years or 10% of the paid-up capital, whichever is less; (b) 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 utilised to set off the losses incurred in the financial year before any dividend in respect of preference or equity shares is declared; and (c) the balance of reserves after such drawal shall not fall below 15% of the paid-up share capital It should be noted that this rule will not apply to declaration of dividend out of the EP CL 22

818 profits/surplus carried forward to the Balance Sheet by a company. It will apply only to declaration of dividend out of the profits of the previous years transferred to the reserves. 4. DECLARATION OF DIVIDEND A dividend when declared becomes a debt and a shareholder is entitled to sue for recovery of the same after expiry of the period of 30 days prescribed under Section 207, in Re Severn and Wye & Severn Bridge Rly. C o. (1896) 1, Ch 559. A dividend when proposed does not become a debt but only becomes debt when declared ( Kastur Chand Jain v. Gift Tax Officer AIR 1961 Cal. 649). The Act does not specifically provide who shall declare final dividend. But under Section 173(1), the declaration of a dividend has been shown as ordinary business at an annual general meeting of a company. Similarly there is a reference to dividend in Section 217 whereunder directors are required to mention in their report to the shareholders the amount, if any, which they recommend by way of dividend. Therefore, it could be assumed that the intention of the legislature is to empower the annual general meeting to declare final dividend. In Raghunandan Neotia v. Swadeshi Cloth Dealers Ltd. (1964) 34 Comp. Cas. 570 (Cal.) the Calcutta High Court held that the cumulative effect of all the provisions of the Act is that the declaration of dividends should be made at the annual general meetings. In Kantilal v.

CIT, (1956) 26 Comp. Cas. 357 (Bom.), the Bombay High Court has held that it is well established and the law is quite clear that a dividend can only be declared by the shareholders of the company. Articles of companies usually contain provisions with regard to declaration of dividends. These will be on the pattern of Regulations 8594 of Table A of Schedule I to the Act. It would be seen that under Regulation 85 the power to declare a dividend vests with the general meeting, but it has no power to dec lare a dividend exceeding the amount recommended by the Board. But if a dividend is so declared at the general meeting, the company cannot declare a further dividend for the same year (Circular No. 2 issued by the Department of Company Affairs dated 25.10.75) There can be no declaration of dividend for past years in respect of which the amounts have already been closed at previously held annual general meeting. [Raghunandan Neotia v. Swadeshi Cloth Dealers Ltd. (Supra)]. Under Section 205(1A) of the Act, the Board of directors is authorised to declare interim dividend. Hence, if articles does not provide otherwise, Board may declare interim dividend. Revocation of Declared Dividend As already stated earlier, a dividend including interim dividend once declare d becomes a debt and cannot be revoked, except with the consent of the shareholders. If a dividend is declared and paid to shareholders, the character of the payment cannot be altered by a subsequent resolution. But where a dividend has been illegally declared, the directors will be justified in revoking the declared dividend. If an illegally declared dividend is paid then the directors shall be responsible, liable and accountable to the company personally.

Payment of Dividend in Cash or in Kind According to Section 205(3), dividend can be paid only in cash, not in kind. The EP CL 22 819 articles may provide that any meeting of the company declaring a dividend may resolve that the dividend be paid wholly or partly by distribution or issue of paid-up shares. In the absence of such express authority dividends may not be paid otherwise than in cash. In one case, where the dividend was paid by allotting shares, it was held that the market value of the shares on the date of the declaration of dividend was to be taken into consideration for computing the income of shareholders for the purposes of tax. State whether the following statement is True or False Dividend can be paid in cash as well as in kind. True False Correct Answer: False According to Section 205(3), dividend can be paid only in cash, not in kind. Liability of Directors, Shareholders and Auditors for Improper Dividend The directors are personally liable to account for improper payment of dividend to the extent to which it has caused loss to the company. If for instance they have paid dividend out of capital they have to compensate the company for the loss. On the other hand, if a member received dividend knowing that it is paid out of capital he is liable to make good the loss to the company and the directors can recover the amount so paid. At the instance of any individual shareholder, the directors can be restrained from going ahead with the payment of an improper and illegal dividend [ Hoo

le v. Great Western Rly Co. (1867) 3 Ch. App. 262]. An auditor who is party to the payment of dividend which is improper is liable to be proceeded against and the amount which is improperly paid may be recovered from him. Shareholders Right to Dividend Once a dividend is declared a shareholder has the right to claim dividend against the company. ( Bacha F. Guzadar (Mrs.) v. CIT (1955) 25 Com. Cases 1: AIR 1955 SC 74). A shareholder cannot compel the company by any process of law to declare a dividend. The usual practice is for the Board to recommend and the annual general meeting to declare the dividend. The annual general meeting will have the power, subject to the provisions of the Act to determine the amount of dividend to be distributed. 5. WHO IS ELIGIBLE TO RECEIVE DIVIDEND Under Section 206 of the Act a dividend in respect of a share has to be paid to the registered shareholder of the share or to his order or to his bankers. For this purpose, usually companies close the register of members under Section 154 of the Act or fix a record date, of which 7 days notice should be given by publication of advertisement in two newspapers one in English and the other in the language of the region in which the registered office of the company is situated. The purpose of such notice is to give an opportunity to those who hold blank transfer deeds to lodge them with the company duly completed. Dividend is paid to those whose names appear on the record date or EP

CL 22 820 the last day of the closure of register of members, as the case may be. The dividend is payable to the shareholder whose name appears in the register of members on the appropriate date even though prior to that date he has sold the shares and the transfer deed in respect thereof has not been lodged with the company [ Chunilal Khushaldas Patel v. H K Adhya ru (1956) 26 Comp. Cas 168 (S.C)]. Recently, it was held in the case of Commissioner of Income-Tax v. Aatur Holdings P. Ltd. [(2008) 146 Comp Cas 152 (Bom)], that merely because a person may have purchased or been in receipt of shares, in the absence of the shares being registered in his name in the books of account of the company, such a person is not entitled to receive the dividend. The dividend has to be paid by the company in the name of the registered shareholders and it is the registered shareholders alone who claim dividend under section 27 of the Securities Contracts (Regulation) Act, 1956. Section 206A was inserted by the Companies (Amendment) Act, 1988 w.e.f. 15.6.1988 providing for right to dividend, rights shares and bonus shares to be held in abeyance pending registration of transfer of shares. It provides that in case instrument of transfer of shares is pending registration with the company, the dividends in relation to such shares should be transferred to the special bank account opened by the

company under Section 205A unless the company is authorised by the registered shareholders in writing to pay such dividend to the transferee specified in the instrument of transfer. In S V Nagarajan v. Lakshmi Vilas Bank Ltd. and another (1997) 26 CLA 308 (CLB) it was held that when a company returns a transfer deed on the ground of nontally of the transferors signature on the deed with the one in its own records, before the date of issue/allotment of bonus/rights shares, there will be no application for registration pending with it on that date and it cannot be faulted for its failure to comply with Section 206A of the Act. 6. WHEN DIVIDEND IS PAYABLE Under Section 207 of the Companies Act, 1956, dividend has to be distributed within 30 days of the declaration. Posting of dividend warrants within 30 days will be deemed to be payment irrespective of the fact whether the warrant has been encashed or not under regulation 91 of Table A of Schedule I to the Act. In the case of joint holders the warrant has to be sent to the registered address of the first named joint holder or to such person and to such address as the joint holders may in writing direct. However, as per proviso to the Section 207 in the following circumstances dividend need not be paid within 30 days viz.: (i) Where dividend could not be paid by reason of the operation of any law e.g. in the case of non-residents, dividend need not be paid within 30 days if permission for remittance where required has not been received therefor from the Reserve Bank of India within 30 days; (ii) Where a shareholder has given directions to the company regarding the payment of dividend and these directions cannot be complied with; (iii) Where there is a dispute regarding the right to receive dividend;

(iv) Where the dividend has been lawfully adjusted by the company against any sum due to it from the shareholder; or (v) Where, for any other reason, the failure to pay the dividend or to post the warrant was not due to any default on the part of the company. EP CL 22 821 N.Kumar v. M.O.Roy, Assistant Director, S.F.I.O [(2007) 80 SCL 55 (MAD)], a company, for the financial year 1995-96, declared the dividend on 19-9-1996 and failed to distribute same within the prescribed period. A complaint has been filed against the company and its directors on 23-8-2006 for the contravention of provisions under Section 207 of the Companies Act, 1956 . A director contended that he had resigned before the declaration of dividend so he could not be held liable for the contravention of Section 207. The court held that the director was not a wholetime director to be aware about the entire affairs of the company. The director could not be held vicariously liable for the contravention under Section 207 and therefore the proceedings were liable to be quashed as against the directo r. Any failure to comply with the requirements of Section 207 renders every director of the company, who is knowingly a party to the default, liable for punishment with simple imprisonment for a term which may extend to three years and he shall also be

lia ble to a fine of one thousand rupees for every day during which such default continues and the company shall be liable to pay simple interest at the rate of 18% p.a. during the period for which default continues. As per Section 55A, non-payment of dividend shall, in case of listed public companies and in case of those public companies which intend to get their securities listed on any recognised Stock Exchange in India be administered by the SEBI. The obligation to post the dividend warrant and the failure to satisfy that obligation would occur at the place where the obligation has to be performed and that place would be the registered office of the company and not the address at which the warrant has to be posted. Hence, jurisdiction to punish an offence under Section 207 is of the Court at the place where the registered office of the company is situated. [ Hanuman Prasad Gupta v. Hiralal (1970) 40 Comp. Cas 1058 (S.C)] Under Section 205A, if a dividend declared by a company has not been paid or claimed within 30 days of the declaration, the same shall within 7 days thereafter i.e. (7 days after the expiry of 30 days from the date of declaration, have to be transferred to a special account to be opened by the company in that behalf in any scheduled bank to be called Unpaid Dividend Account of................Company Limited/Company (Private) Limited. Subsequently dividend claims will be met from this account. According to Section 205A(5), if any amount remains unpaid or unclaimed for a period of seven years from the date of such transfer, the amount so remaining unpaid/unclaimed together with any interest credited thereto should be transferred to the Investor Education and Protection Fund. The company had deposited the unpaid dividend into the special dividend account. Unless the petitioners had got knowledge about non-encashment, the question of transferring the said amount to an unpaid dividend account would not

arise, because that amount was already in that account. [ Kr ebs Biochemicals Ltd. v. ROC (2002) CLC 1564 (AP)]. The foregoing provisions shall equally apply to payment of interim dividend. Under Section 205(3) dividend has to be paid in cash. Dividend can be distributed in cash or by issue of a cheque or warrant. In Krebs Biochemicals Ltd. & Ors. v. ROC [(2003) 57 CLA 75 (AP)], the company transferred dividend to a special dividend account and also Post dividend EP CL 22 822 warrants to the shareholders within the stipulated 42 days (now 30 days) from the date of the declaration of dividend. The Registrar of companies carried out an inspection of the company on 29.09.1997 and concluded that the company had failed to transfer the unpaid dividend to the special account within the time stipulated under Section 205A(1) of the Act. The ROC initiated prosecution proceedings against the company and its directors and filed a complaint on 15.4.1998. The company and its directors challenged the prosecution before the High Court contending that it had deposited the entire dividend amount in a separate dividend account and dispatched th e dividend warrants within stipulated time and that the complaint of ROC was

barred by limitation also (which is 6 months as per Section 468(2) of Cr.P.C.). Allowing the appeal of the company, the Court stated that once the limitation period begins, it cannot be stopped. The averments made in the complaint do not constitute an offence under Section 205A (8) of the Act and is barred by limitation. Choose the correct answer Within how many days from the date of declaration, the dividend has to be distributed? (a) 10 days (b) 20 days (c) 30 days (d) 60 days Correct Answer: (c) 30 days 7. ESTABLISHMENT OF INVESTOR EDUCATION AND PROTECTION FUND The provisions of Section 205C inserted with effect from 31.10.1998 are as follows: The Central Government shall establish a fund to be called the Investor Education and Protection Fund (hereafter referred to as the Fund) [Sub -section (1)]. As per sub-section (2), there shall be credited to the Fund the following amounts, namely: (a) amounts in the unpaid dividend accounts of companies; (b) the application moneys received by companies for allotment of any securities and due for refund; (c) matured deposits with companies; (d) matured debentures with companies; (e) the interest accrued on the account referred to in clauses (a) to (d); (f) grants and donations given to the Fund by the Central Government, State Government, companies or any other institutions for the purposes of the Fund; and (g) the interest or other income received out of the investments made from the Fund.

However, no such amounts as mentioned in (a) to (d) above shall form part of the Fund unless such amounts have remained unclaimed and unpaid for a period of seven years from the date they became due for payment. EP CL 22 823 The explanation to Sub-section (2) of Section 205C clarifies that no claims shall lie against the Fund or the company in respect of individual amounts which were unclaimed and unpaid for a period of seven years from the dates that they first became due for payment and no payment shall be made in respect of any such claims. The Fund shall be utilised for promotion of investor awareness and protection of the interests of investors in accordance with such rules as may be prescribed [Subsection (3)]. The Central Government shall, by notification in the Official Gazette, specify an authority or committee, with such members as the Central Government may appoint, to administer the Fund, and maintain separate account 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 [Sub-section (4)]. It shall be competent for the authority or committee appointed under Sub-section (4) to spend moneys out of the Fund for carrying out the objects for which the Fund has been established [Sub-section (5)]. 8. DIVIDEND WARRANTS Clause (b) of Section 205(5) specifically provides that any dividend payable in cash may be paid by cheque or warrant and it shall be deemed to have been paid when the cheque or warrant therefor is posted to the registered address or to such other address as provided by the shareholder entitled to the payment of dividend. So far as the company is concerned, the person entered in the Register of members is

the holder of shares though he may be merely a benamidar having no beneficial interest in the shares for another person (a beneficiary). Dividend warrant is an order by the company to its banker to pay the amount specified therein to the shareholder whose name is written therein. The shareholder may, at his discretion thereafter draw the amount of the warrant from his account with the bank and with whom he deposits the warrant for collection. A company cannot take any notice of any private arrangement between the vendor and purchaser of shares. If a dividend warrant issued to but not received by a shareholder, is encashed by an unauthorised person directly or indirectly, the company will have to bear the loss, because in such cases the dividend cannot be said to have been paid to the registered holder within the meaning of Section 206. For this reason, a warning note is printed on the reverse of the dividend warrant to save the company from the liability due to dividend warrant falling in hands of fraudulent persons. However, companies have also been authorised to make the payment of dividend through ECS facility. Distribution of dividend through ECS 1. DCC/FITTC/Cir-3/2001 dated 15.10.2001 issued by the SEBI, Depositories and Custodian Cell It has been brought to our notice that some of the companies are not utilising the facility of Electronic Clearing Services (ECS) for distributing dividends, other cash benefits, etc., to the investors. It is advised that all the companies should mandatorily use ECS facility wherever available. In the absence of availability of ECS facility, the companies may use warrants for distributing the dividends. EP CL 22 824 2. DCC/FITTC/Cir-4/2001 dated 13.11.2001 issued by SEBI, Depositories and

Custodian Cell Please refer to our Circular No. DCC/FITTC/CIR-3/2001, dt. 15.10.2001. It is further advised that at present only some of the companies print the bank account details of the investors on the warrants (payment instrument), for distribution of dividends, other cash benefits, etc. There are some companies, which are not printing the bank account details on the payment instruments. SEBI has also received complaints about fraudulent encashment of the dividend and other cash benefit instruments. To avoid such situations the companies are advised to mandatorily print the bank accounts details furnished by the depositories, on the payment instruments. * Dividend Mandate * The shareholders may desire that their dividends be credited directly to their bank account. The request will be made in a form duly filled and sent to the company. Thi s is known as Dividend Mandate. This authorises the company to pay dividends directly to bank account of the shareholder. This form is also used for purposes like payment of interest on debentures and other securities. Use of information technology in cash transaction of listed companies for payment of dividends The shareholders have complained in the past about loss of dividend warrants sent by post due to pilferage in transit or undue delay in receipt of dividend warrants through post. Under Section 205(5)(b) of the Companies Act, 1956 a company may remit dividend in cash or by cheque or by warrant. It is however well-known that the amount of dividend can also be transmitted electronically to the shareholders after obtaining their consent in this regard and asking them to nominate the specific bank account number to which the dividend due to them should be remitted. The Central Vigilance Commissioner has issued an order dated 27.11.1998 directing that the Banks may switch over to remittance of dividends by computerised

means as it will help to improve the vigilance administration. The Central Vigilance Commissioner has also requested the Department of Company Affairs (now Ministry of Corporate Affairs) that in the interest of greater transparency listed companies in India may be directed that they should go in for computerised cash transaction so far as payment of dividend, interest, refund etc. are concerned. Consequently, the Ministry of Corporate Affairs, has now advised listed companies to encourage their shareholders to send their authorisation to remit dividend to their designated bank account by means of electronic transfer as this will result in avoiding delay in remittance of dividends etc. Can Dividends be Paid out of Capital Dividend cannot be paid out of capital, even if the articles of association * The TDS may be printed on the reverse side of the Counterfoil (of the Dividend Warrant) duly signed by persons responsible for deduction of tax. General Circular No. 10/2003 dated 13.02.2003. EP CL 22 825 authorise such payment. As per Section 205, dividend may be paid out of the following three sources only: out of current profits; out of profits for any previous financial year or years; and out of moneys provided by the Central or State Government for the payment of dividend. Directors who knowingly paid dividends out of capital shall be held personally

liable to make good the amount to the company. When a misrepresentation was made to the shareholders by the directors that the dividends were being paid out of profits while they were actually paid out of capital, the shareholders would not be accountable and the directors alone would be accountable to the company [ Oxford Benefit Building & Investment Society, In re (1886) 35 Ch. D 502 ]. But if the members knowingly received dividend which was paid out of capital, the directors would have a right of indemnity against such members. The shareholders cannot keep the dividend with them and have to return the amount received to the company (Towers v. African Tug Co. (1904) 1 Ch. 558 (CA) Moxham v. Grant (1900) 1 QB 88 (CA). In another case, due to an unintentional mistake on the part of the directors, dividend was paid out of capital, on realising/mistake the directors recovered such dividend. No action can be taken against such directors. State whether the following statement is True or False Dividend can be paid out of capital only when the Articles of Association authorise such payment. True Fa lse Correct Answer: False

Dividend cannot be paid out of capital even if the Articles of Association authorise such payment. 9. PAYMENT OF INTEREST OUT OF CAPITAL The normal rule of law is that dividend can be paid only out of profits and must not be paid out of capital. An exemption to the rule is contained in Section 208 which, in effect, provides that where shares are issued to raise money to defray the cost of works or building or of plant or project which cannot be made profitable for a long period, the company may pay interest on the amount of the capital paid-up in respect of such shares and may charge the same to capital as part of the cost of works, buildings or project or plant provided the following conditions are satisfied: (a) Authority and Sanction of the Central Government The payment should be authorised by the articles. In the alternative, a special resolution is passed and prior sanction of the Central Government is obtained. Prior sanction of the Central Government is necessary even when the articles authorise such payment. Before sanctioning any such payment, the Central Government is empowered to appoint a person to inquire into and report to the Central EP CL 22 826 Government on the circumstances of the case. It may even require the company to give security for payment of the costs of the inquiry. (b) Time Period The payment of interest shall be made only for such period as

may be determined by the Central Government and that period shall in no case extend beyond the close of the half-year next after the half-year during which the work or building has been actually completed or the plant provided. (c) Rate of Interest The rate of interest shall, in no case, exceed four per cent per annum or such other rate as the Central Government may notify in th e Official Gazette. (d) Charge to Capital The payment of interest shall not operate as a reduction of the amount paid up on the shares in respect of which it is paid. Payment of Dividend out of Capital Profits The term capital profits may be defined to mean those profits which arise otherwise than in the normal course of the business and earned out of capital transactions. The usual sources of capital profits are: (1) Profits on sale of fixed assets. (2) Profits on revaluation of fixed assets. (3) Premium on issue of shares/debentures/bonds/redemption of debentures. (4) Profits on reissue of forfeited shares. (5) Capital redemption reserve account. (6) Profit prior to incorporation i.e. profits which accrues to a company till the date of incorporation. The Companies Act does not mention specifically whether capital profits i.e. profits which arise where a company sells part of its fixed assets at a price higher than the original cost of such asset, can be distributed as dividend.

However, in the two important cases of Lubbock v. British Bank of South America (1892) 2 Ch. 198 and Foster v. The New Trinidad Lake Asphalt Co. Ltd. (1901) 1 Ch.208 the courts have held that capital profits cannot be considered as available for distribution as dividend unles s: (a) the articles of association authorise such a distribution; and (b) the surplus is realised and remains after a valuation of the whole of the assets and liabilities. 10. REMITTANCE OF DIVIDEND OR INTEREST OR SALE PROCEEDS TO NRI S , FOREIGNERS AND FOREIGN COMPANIES In terms of Foreign Exchange Management (Current Account Transaction) Rules, 2000 read with AD (MA Series) Circular No.11, dated 16.5.2000, an authorised dealer is empowered to remit payment of dividend by Indian companies to non -resident shareholders. For the purpose, the authorised dealers are empowered EP CL 22 827

to devise their own documentation complying with Section 10(5) of Foreign Exchange Management Act, 1999. Rate of Dividend on Preference Shares Schedule 1 to Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 prescribe the rate of dividend on preference shares or convertible preference shares issued under these regulations. Accordingly, the rate of dividend shall not exceed 300 basis points over the Prime Lending Rate of State Bank of India prevailing as on the date of the Board Meeting of the company in which the issue of such share is recommended. Students may note that the Institute has published Secretarial Standard on Dividend (SS-3) and a Guidance Note on Dividend. State whether the following statement is True or False If a dividend is declared and paid to shareholders, the character of the payment cannot be altered by a subsequent resolution. True False Correct Answer: True ANNEXURE I CLARIFICATIONS OF THE DEPARTMEN