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 ProvisionsSection 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 SplitComparison --- Bonus Issue and Stock Split

Bonus Issue Stock Split

Par Value Unchanged Reduces

Reserves Capitalised

Yes No

Shareholders’ Proportional

Holding

Unchanged Unchanged

Book Value per share, EPS and

market price

Declines Declines

Market Price per Share is brought within a popular

trading range

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

RD + (E—D)x ------

KP = ----------------------------------

KWhere,P = Price per shareD = Dividend per shareE = Earning per shareR = Rate of return on investmentsK = Cost of capital or Shareholders expectations

Growth Company

R > K

Normal Company

R = K

Declining Company

R < K

R = 20 % 15 % 10 %

K = 15 % 15 % 15 %

E = Rs 4 Rs 4 Rs 4

If D = Rs 4 Rs 4 Rs 4

Then P = Rs 26.67 Rs 26.67 Rs 26.67

If D = Rs 2 Rs 2 Rs 2

Then P = Rs 31.11 Rs 26.67 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 %

30 30 30 30

PAT 70 70 70 70

Dividend Payout Ratio 22 %

15.40 15.40 15.40 15.40

Tax at Investor Level

Nil 1.54 3.08 4.62

After – Tax Dividend

15.40 13.86 12.32 10.78

Total tax paid to Govt.

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 %

30 30 30 30

PAT 70 70 70 70

Dividend Payout Ratio 22 %(Dividend 20 %

and Tax 10 %)

14

+

1.40

14

+

1.40

14

+

1.40

14

+

1.40

Tax at Investor Level 1.40 1.40 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