Dividends Paid Out of Capital

 What do you mean by the statement “dividends are paid out of capital”? How can dividends be paid out of capital and what are the consequences if dividends are paid out of capital ?

Dividends are said to be paid out of capital when the company voluntarily returns to the shareholders some part of the money they had paid for their shares. In other words, the payment of dividend out of capital means the payment of dividend out of the assets acquired with the paid-up capital of the company. Under the law, dividends must only be paid out of profits and cannot be paid out of capital and if the Memorandum or Articles of Association give power to the company to do so, such power is invalid

 What do you mean by the statement “dividends are paid out of capital”? How can dividends be paid out of capital and what are the consequences if dividends are paid out of capital ?

Dividends are said to be paid out of capital when the company voluntarily returns to the shareholders some part of the money they had paid for their shares. In other words, the payment of dividend out of capital means the payment of dividend out of the assets acquired with the paid-up capital of the company. Under the law, dividends must only be paid out of profits and cannot be paid out of capital and if the Memorandum or Articles of Association give power to the company to do so, such power is invalid ( Verner v. General & Commercial Invsetment Trust. Ltd., 1948). Dividend is a return on capital and not a return of capital. Dividends will be paid out of capital in the following circum-stances :

When any revenue expenditure is charged to capital in order to inflate profits. When a company distributes the sale proceeds of one of its fixed assets. (iii) When a company pays dividend in spite of the fact that the Profit and Loss Account shows a loss and there are no other undistributed profits. The following consequences will result if dividends are paid out of capital:

(i) The directors who knowingly pay dividends out of capital shall be jointly and severally liable to replace the amount with interest at 5% per annum ( Oxford Benefit Building Society 1886; re London General Bank 1895; re Kingston Cotton Mills Company, 1896). If, however, the directors acted honestly and relied upon a bona fide valuation of company’s assets by the trusted officers of the company, which subsequently proved to be an over-estimate, the directors will not be liable for a dividend wrongly paid (Stpinger’s case 1869; Rance’s case 1870. But if the Articles stipulate that dividends are only payable out of realised profits, the directors may be responsible for a dividend paid out of estimated profits (Oxford Benefit Building Society, 1886). (ii) The amounts of dividend paid out of capital to shareholders may be recovered from them, if they received the dividend with full knowledge of the facts (Moxham v. Grant, 1900); but the directors will primarily be liable to the company, (iii) The auditor will be liable for damages when the results shown by the accounts have been overstated, resulting in the payments of dividend out of capital, and the auditor could have discovered it by the exercise of reasonable care and skill.

 

 

Updated: July 12, 2019 — 6:57 am

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