A dividend is a manner in which a company shares its wealth, which it generates out of the course of business with the shareholders. Dividends are paid to a shareholder on a quarterly or half yearly or on an annual basis. Dividends, by the name of dividends have to be mandatory paid in cash as per Section 205 (3) of the Companies Act 1956. However, another form of dividend though not termed, as dividend is the issue of bonus shares, which for all financial purposes is also a proxy for dividends. Companies have an option of paying out dividends out of their current earnings after tax or out of retained earnings. Companies in a high growth phase normally deploy the complete earnings in the business and so tend to not give dividends, but companies, which are in a stable phase, normally share it with the investors as dividends.

Implications of Dividends

Implications to the Company

A company paying out dividend, would normally create a liability in their books termed as “dividend payable”, which gets removed as soon as the dividend is paid, which happens a few weeks after the ex-date. The company also has to pay a dividend tax on the amount of dividends paid. The amount of earnings after tax reduced by the amount of dividend and dividend tax is then transferred to the Reserves in the Balance Sheet.

In the case of bonus shares, though, the amount is removed from reserves and is added to the Equity Capital Account at face value. New shares are issued to the shareholders at par. For instance, for issue of bonus shares of face value, Rs 10, to the extent of a 10% dividend with 100 million shares outstanding, retained earnings is reduced by Rs 1 billion, and equity share capital is increased by that much amount. The total number of shares outstanding then increases to 110 million from an earlier 100 million.

Implications on the Share Price

On the ex-dividend date, the price of the share is adjusted downward by the amount of dividend per share, as this amount so paid does not belong to the company any more. The dividend amount now belongs to the shareholders and not the company and so should not be carried in the price of the company. This also implies that any investor becoming a shareholder after the ex-date would not have a right to the dividend, as he gets the share at a price lower by that much amount.

Implication on the Shareholder

The shareholder gets the dividend after the company has paid corporate income tax on its earnings and an over and above dividend distribution tax. Therefore, the amount of dividend earned by the shareholder is tax free in the hands of the investor. However, the interest so earned out of this dividend from the bank account to which it has been deposited will be taxable in the hands of the investor (with the exception of NRE Accounts-Section 10(3)(ii) of the Income Tax Act).

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