Dividend
Policy
 Dividend is proposed by the Board of Directors
and declared by the Shareholders at the Annual
General Meeting.
 AGM cannot increase the dividend but
can reduce the dividend.
 Interim dividend can be declared and paid
by the Board of Directors.
Legal Provisions
Section 205 of the Companies act: -
(1) Only out of the profits after providing for Depreciation
(as per section 350 of the Companies Act / Schedule XIV)
or out of past profits after providing for Depreciation or
out of both or out of monies provided by the Central /
State Govt. for payment of dividend pursuant to a
guarantee given by the Govt.
(2) The amount of dividend must be deposited in a separate
Bank Account within five days from the date of
declaration of dividend.
(3) No dividend shall be paid except after transfer to
Reserves (not exceeding 10 % of the profits)as may be
prescribed. Voluntary transfer of higher percentage is
allowed.
(4) No dividend shall be paid except in CASH.(Cheque /
Warrant)
Legal Provisions
(Continued)
(5) Company can issue fully paid Bonus shares by
capitalizing past profits or Reserves.
Section 205 A of the Companies act: (1) Where dividend declared has not been paid or claimed
within 30 days from the date of declaration of dividend,
then the company shall transfer such unpaid / unclaimed
dividend to a special account called “Unpaid Dividend
Account” within seven days from the expiry of 30 days as
aforesaid.
(2) Any unpaid dividend remaining unpaid / unclaimed for a
period of seven years shall be transferred to “Investor
Education and Protection Fund”
(3) In case of loss, company can pay dividend out of past
profits / reserves as per Companies (Declaration of
Dividend out of Reserves)Rules, 1975.
Companies (Transfer of Profits
to Reserves) Rules, 1975.
Dividend Percentage
Percentage of Profit to
be transferred to
Reserve
More than 10 % but
up to 12.5 %
Not less than 2.5 %
of the Current Profits
More than 12.5 % but
up to 15 %
Not less than 5 %
of the Current Profits
More than 15 % but
up to 20.0 %
Not less than 7.5 %
of the Current Profits
More than 20 %
Not less than 10 %
Minimum Dividend when higher amount transferred to Reserves
If Company proposes to transfer higher amount to Reserves than
prescribed, then minimum dividend has to be declared as under: 1. Dividend Rate equal to Average Rate of Dividend declared in
preceding three years
2. If Bonus Shares issued in the preceding three years, then the
quantum of Dividend should be Average Quantum of Dividend
declared in the preceding three years. (Here, the Rate will be
lower)
3. If the Profits are lower by 20% or more than the Average Profit of
the preceding two years, then the requirement of Minimum
Dividend does not apply.(Higher amount can be transferred to
Reserves without declaring Minimum Dividend)
Companies (Declaration of Dividend
out of Reserves) Rules, 1975
In the case of losses, following rules will apply: (1) Rate of Dividend not to exceed average of the previous
5 years’ dividends or 10 % of paid up Capital,
whichever is less.
(2) Amount to be drawn from the Reserves not to exceed
10 % of the Paid- up Capital and Free reserves and to
be utilised first to set off losses of the year
(3) Residual Reserves not to fall below 15 % of the Paid-up
Share Capital.
SEBI Guidelines for Issue of Bonus Shares
1. Only out of free reserves and share premium
2. No revaluation reserve can be used.
3. Residual reserves after Bonus Issue shall be
at least 40 % of the increased Paid-up Capital.
4. 30 % of the Average PBT for the previous three
years should yield a dividend rate of 10 % of
expanded capital
5. Revaluation reserve not considered for
Residual reserve
6. Bonus Shares cannot be issued in lieu of Dividend
7. Company has not defaulted in payment of
Interest or Principal on FDs or Debentures,
statutory dues of employees
8. No bonus issue shall be made within 12 months of
any public or right issue.
Calculate the Maximum Bonus Ratio
(Rs in Lacs)
Case I
Case II
Case III
Share Capital
100
100
100
Free Reserves
40
100
150
30% of Avg. PBT
for Previous 3
Years
45
45
45
Determinants of Dividend Policy
1. Earnings of the Company
2. Trend of Earnings
3. Desire of the shareholders
4. Management considerations
5. Nature of the industry
6. Age of the Company
7. Liquidity Position/Fund raising Capacity
8. Taxation Policy of the Govt..
9. Inflation
10.Future plans of the Company
11.Negative Covenants in Loan Agreements
12.Legal Restrictions
Types of dividend Policy
1. Constant Payout Ratio Policy
2. Constant Dividend Rate Policy
3. Regular dividend + Extra Dividend Policy
4. Uniform Cash Dividend + Bonus Shares Policy
Comparison --- Bonus Issue and Stock Split
Bonus Issue
Stock Split
Par Value
Unchanged
Reduces
Reserves
Capitalised
Shareholders’
Proportional
Holding
Book Value per
share, EPS and
market price
Market Price per
Share is brought
within a popular
trading range
Yes
No
Unchanged
Unchanged
Declines
Declines
Yes
Yes
Provisions pertaining to Buyback of Shares
1. Special Resolution
2. Completed within 12 months from shareholders’ approval
3. Post Buyback Debt:Equity Ratio not to exceed 2 : 1
4. Buyback not tot exceed 25 % of Total Paid-up Capital
and Free Reserves
5
No further issue of Equity within 24 months except
by way of Bonus Issue,Conversion of Debentures
etc,Stock Option, Sweat Equity
6
Funding may be by – Free reserves and Share Premium,
Cash from disposal of Capital Assets, Public Issue for this
specific purpose and Debenture Issue
7 Cannot be done through Negotiated Deals (Few
Shareholders)
8
Process handled by qualified Merchant Banker
Walter’s Model
R
D + (E—D)x -----K
P = ---------------------------------K
Where,
P = Price per share
D = Dividend per share
E = Earning per share
R = Rate of return on investments
K = Cost of capital or Shareholders expectations
R=
Growth
Company
R>K
20 %
Normal
Company
R=K
15 %
Declining
Company
R<K
10 %
K=
15 %
15 %
15 %
E=
Rs 4
Rs 4
Rs 4
If D =
Then P =
If D =
Then P =
Rs 4
Rs 26.67
Rs 2
Rs 31.11
Rs 4
Rs 26.67
Rs 2
Rs 26.67
Rs 4
Rs 26.67
Rs 2
Rs 22.22
Conclusions from Walter’s Model
1. Where R > K, Market Price increases as the Payout Ratio decreases
2. Where R = K, Market Price does not vary
3. Where R < K, Market Price increases as the Payout Ratio increases
Therefore, Optimal Payout Ratio for
Growth Company is NIL
Normal Company is IRRELEVANT
Declining Company is 100 %
EPS = Rs 4
Rate of return on Investments = 18 %
Shareholders’ Expectations = 15 %
What will be the Market Price if
the Payout Ratio is 40 %, 50 % and 60 % ?
Income Tax on Distributed Profits
Dividend is Tax-free at the hands of the receiver
u/s 10(34) of the Income Tax Act.
However, Company has to pay Dividend Distribution
Tax within 14 days from the date of declaration of
dividend.
W.E.F. 1st April 2005, Dividend Distribution Tax is
12.5% plus surcharge of 1.25% plus Education Cess
@ 2% on (Tax Plus Surcharge) i.e. 14.025%
Impact of Dividend Tax on
After – Tax Return to Shareholders
Alternative A ----- No Dividend Tax
Exempt
10 %
20 %
30 %
PBT
100
100
100
100
Corporate Tax
@ 30 %
PAT
30
30
30
30
70
70
70
70
Dividend Payout
Ratio 22 %
Tax at Investor
Level
After – Tax
Dividend
Total tax paid to
Govt.
15.40
15.40
15.40
15.40
Nil
1.54
3.08
4.62
15.40
13.86
12.32
10.78
30
31.54
33.08
34.62
Impact of Dividend Tax on
After – Tax Return to Shareholders
Alternative B ----- Dividend Tax @ 10 %
Exempt
10 % 20 %
30 %
PBT
100
100
100
100
Corporate Tax
@ 30 %
PAT
30
30
30
30
70
70
70
70
Dividend Payout Ratio
22 %(Dividend 20 %
and Tax 10 %)
Tax at Investor Level
14
+
1.40
1.40
14
+
1.40
1.40
14
+
1.40
1.40
14
+
1.40
1.40
After – Tax Dividend
12.60
12.60 12.60
12.60
Total tax paid to Govt.
31.40
31.40 31.40
31.40