Dividend Properly so called under General Law, Paid Out of Capital Profits Under Dividend

In India, the concept of dividends is of paramount importance in the corporate world. Dividends are essentially the rewards distributed to the shareholders out of the company's profits. It is a crucial aspect of corporate governance and is regulated by various laws and regulations. However, there are specific legal nuances concerning dividends paid out of capital profits that need to be understood.

What is a Dividend?

A dividend is a distribution of a portion of a company's earnings to its shareholders. It is essentially a reward for the investment made by the shareholders in the company. Companies generally pay dividends in the form of cash, but they can also distribute them in the form of additional shares of stock or other property.

Dividend under Indian Company Law

Under the Indian Company Law, a company can declare and pay dividends to its shareholders out of its profits. As per Section 123 of the Companies Act, 2013, a company can distribute dividend out of profits generated in the current financial year or any previous financial year after the deduction of depreciation and taxes. This means that a company cannot declare and distribute dividends out of its capital profits.

What are Capital Profits?

Capital profits refer to profits that are generated from capital transactions such as the sale of assets, investments, or any other capital-intensive activities. These profits are not considered as distributable dividends as they do not represent the earnings generated by the company's operations.

Distribution out of Capital Profits

The Companies Act, 2013 explicitly prohibits the distribution of dividends out of capital profits. Section 123(5) of the Act states that a company cannot declare or pay dividends unless the losses of the previous financial years are set off against the profits of the current financial year. By setting off the losses against the profits, the company ensures that the dividends are paid out of the genuine profits earned by the company through its operations.

Consequence of Paying Dividends out of Capital Profits

If a company pays dividends out of capital profits, it can have various legal and financial implications. Firstly, it can lead to a decrease in the company's capital base, which can have a negative impact on the company's financial stability and creditworthiness. Secondly, it can lead to legal consequences as the directors and officers of the company can be held personally liable for such wrongful distribution of dividends.

Determining Availability of Profits for Dividend

Companies need to follow certain procedures to determine the availability of profits for distribution as dividends. As per Section 129 of the Companies Act, 2013, a company needs to prepare financial statements to determine the availability of profits for dividends. These financial statements include the balance sheet, profit and loss account, cash flow statement, and statement of changes in equity.

Role of Board of Directors

The declaration and payment of dividends are typically done by the board of directors of the company. The board has the responsibility to ensure that the dividends are paid out of the genuine profits earned by the company. The board also needs to ensure that the company complies with the provisions of the Companies Act, 2013 and other relevant laws while distributing dividends.

In addition to the Companies Act, 2013, there are various other legal provisions that regulate dividend distribution in India. The Securities and Exchange Board of India (SEBI) has also laid down certain regulations governing the declaration and payment of dividends by listed companies. These regulations ensure transparency and fairness in the dividend distribution process.

Tax Implications of Dividend Distribution

Dividends distributed by a company are also subject to taxation. As per the Income Tax Act, 1961, dividends are divided into two categories – taxable dividends and exempt dividends. Taxable dividends are subject to income tax, while exempt dividends are not taxable in the hands of the shareholders. Companies need to ensure compliance with the tax laws while declaring and paying dividends to the shareholders.

Striking the Right Balance

While dividends are essential for rewarding the shareholders and attracting new investors, companies need to strike the right balance in dividend distribution. Paying dividends out of capital profits can have detrimental effects on the financial health of the company and can lead to legal repercussions. Companies need to ensure that dividends are paid out of the genuine profits earned through their operations.

Conclusion

In conclusion, dividends are an essential aspect of corporate governance and play a crucial role in rewarding the shareholders. However, dividends paid out of capital profits are prohibited under the Indian Company Law. Companies need to adhere to the legal provisions and ensure that dividends are paid out of the genuine profits earned through their operations. By doing so, companies can maintain their financial stability and comply with the regulatory framework governing dividend distribution.