A dividend is the portion of distributable profits that is actually distributed to shareholders. It includes interim dividends as well. Companies pay dividends out of the profits of the year for which they intend to declare a dividend or from any of the previous financial years, or from both, after providing for depreciation. Sources of dividends include current year profits, accumulated profits from preceding financial years, and funds provided by the central or state government for the payment of dividends pursuant to any guarantee given by them, sometimes in cash or kind. Dividends must be deposited into a separate bank account within five days after declaration. Once declared, the dividend becomes a debt owed by the company to its shareholders, and it cannot be revoked thereafter.
There are generally two types of dividend that the companies announce from time to time to their equity shareholders.
1. Final Dividend.
2. Interim Dividend.
The Company sets the eligibility criteria for the general public (i.e. say investors) to qualify for the dividend. They announce the ex-dividend date and record date for this purpose.
Let’s understand the terms ‘ex-dividend date’, ‘record date’ and ‘dividend date’.
1. Ex-dividend date: This is the cutoff date set by the company to determine which shareholders are eligible to receive the upcoming dividend payment. If you buy the stock on or after this date, you will not receive the dividend. To be eligible for the dividend, you must be a shareholder before the ex-dividend date. Therefore, you need to buy the stock at least one day before the ex-dividend date.
e.g. If MNO Co. announces it will pay a dividend of ₹1 and the ex-dividend date is February 3, you must buy the stock before this date (at least one day before February 3) to become an eligible shareholder to receive the ₹1 dividend.
2. Record date: This is the date that determines which shareholders are eligible to receive a dividend. If you are on the company’s books as a shareholder on the record date, you will receive the dividend, irrespective of when you buy the share. The record date is typically two business days after the ex-dividend date or may be on the same day.
e.g. If MNO Co. announces it will pay a dividend of ₹1, and the ex-dividend date is February 3, you must buy the stock before this date to become an eligible shareholder. The record date in this case would be February 5, and if your name is listed in the company’s shareholder register, you are entitled to receive the dividend.
3. Dividend date: Also known as the payment date, this is when the company actually distributes the dividend to eligible shareholders. This typically occurs one or two weeks after the record date.
e.g. If MNO Co. announces a ₹1 dividend, the ex-dividend date is February 3, and the record date is February 5, the payment date would be February 10, when the company distributes the dividend to shareholders.
→ The Ex-dividend date and the Record date are related but serve different purposes in the dividend process.
→ Difference Between the Ex-date and Record date:
1. The ex-date determines who will not receive the dividend, whereas the record date tells us who will receive the dividend.
2. The ex-date plays an important role in determining whether you are eligible to buy the stock and become a shareholder, whereas the record date is not relevant for buying or selling shares.
3. Price adjustment typically happens on the ex-date, as the stock price generally falls by the amount of the dividend. No such adjustment happens on the record date.
→ Now we discuss types of Dividend.
Each dividend type serves a different purpose, depending on the company’s financial, social, political and policies.
- Interim Dividend: Declared before the company’s annual general meeting (AGM) based on the company’s performance for part of the year. It is often paid when the company performs well and wants to distribute earnings during the year. It is declared based on a pro-forma profit and loss (P&L) account.
2. Final Dividend: Final dividends are declared after the financial year ends and are based on the company’s full-year performance. They are typically declared at the AGM and are based on the audited P&L account.
3. Special Dividend: A special dividend is a one-time payment made by the company, often after an extraordinary event like the sale of a business unit or receiving an exceptionally large profit.
4. Preferred Dividend: These are dividends paid to preferred shareholders, who receive fixed dividends before common shareholders are paid. This is more common for companies that have issued preferred shares
→ What is the effect on the price of Stock after the company announces the Dividend?
After a company announces a dividend, if the company meets the expectations of investors, the stock price typically reacts positively from the announcement date to the ex-dividend date. On the ex-dividend date, the stock price generally drops by the amount of the dividend. This occurs because the value of the dividend is now separated from the stock.
Why do the prices drop?
The simple answer is that the dividend payout represents cash leaving the company, so the overall value of the company decreases by that amount. However, after a while, market factors and conditions may neutralize the stock price accordingly. It’s important to note that the price does not always fall by the exact amount of the dividend.
♦ The Brief journey from Dividend Announcement to Distribution.
→ On the dividend announcement date, the company declares the dividend amount along with the ex-dividend date and the record date. The market reacts to this news, and if investors’ expectations are met, the stock price rises. However, if the company fails to meet expectations, the stock price may fall slightly. This phenomenon is observed in the market, where, apart from the company’s strong fundamentals and financial health, investor sentiment plays a significant role.
→ Many new investors buy the stock after hearing the dividend news, hoping for a good payout. Dividend income is considered special income, so investors seek to take advantage of it. Up to the ex-dividend date, the stock price may rise by 15% to 17%. Increased trading volume is also common, as investors, after ensuring they will receive the dividend, sell the stock. Not all investors are long-term holders; many sell their stocks after the ex-dividend date.
→ e.g. If MNO Co. declares a ₹24 dividend per share, with an ex-dividend date of February 10, record date of February 12, and payment date of February 19, you must own the stock by February 9. If you sell the stock on February 10 (the ex-dividend date), you are still eligible to receive the dividend. Afterward, on the record date, your name is listed in the shareholder’s register, and on the payment date, your bank account is credited with the dividend payout.
♦ Taxability of Dividend
- In the Hands of Companies
→ Since April 2020, companies are no longer responsible for paying tax on dividend distributions. Before 2020, there was a Dividend Distribution Tax (DDT) of 15% (plus surcharge and cess), making dividends tax-free in the hands of shareholders.
→ Now, companies only distribute dividends and are no longer responsible for tax payments on behalf of shareholders.
→ However, companies must deduct Tax Deducted at Source (TDS) under section 194 at 10% for dividend payments exceeding ₹5,000 to a single shareholder. If the shareholder doesn’t provide their PAN, TDS is deducted at the highest rate of 20%.
- In the Hands of Shareholders
→ For Domestic Companies( in capacity of ShareHolder)
Dividends received by a domestic company from another Indian company are exempt under section 10(34) of the Income Tax Act, 1962.
→ For Individual shareholders
Dividends are taxable under the head “Income from Other Sources” and taxed according to the individual’s income tax slab. Dividends up to ₹5,000 are exempt, but amounts above ₹5,000 are taxed according to the applicable slab rates.
Companies deduct TDS at 10% on dividends exceeding ₹5,000.
→ For Foreign Shareholders
Dividends paid to foreign investors (such as non-resident Indians or foreign companies) are subject to TDS at a rate of 20%.
→ Shareholders must declare their dividend income in their income tax returns. If TDS has been deducted from the dividend income, the total income (including TDS) must be declared.
e.g. If an individual shareholder receives ₹15,000 as dividend income in a financial year and TDS of 10% (₹1,500) has been deducted, they will receive ₹13,500. However, they need to declare the gross dividend income of ₹15,000 and pay tax accordingly. They may be eligible for a refund of the TDS later.
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