How does Profit-Sharing Work Among Partners in a Private Limited Company?

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How does Profit-Sharing Work Among Partners in a Private Limited Company?

Most people are aware that when it comes to partnerships, partners just need to calculate the profits and distribute it among partners in a predetermined profit-sharing ratio as per the partnership agreement. However, when it comes to private limited companies, there are no official partners but directors and shareholders. So, how the profits are distributed in companies? Let’s find out!

Difference Between Directors and Shareholders

Before understanding the distribution of profits in private limited companies, we need to understand the difference between directors and shareholders. Directors are like the agents of the company they are responsible for running the company. All the decisions relating to day-to-day operations and management of the company are taken by the directors except for certain specified decisions that require the participation of shareholders.

Shareholders are the owners of the company that have invested their money in form of share capital. While they may not be involved in the operation and management of the company, shareholders get involved in certain critical decisions that require their participation as per the law. A director can also be a shareholder of the company.

Distribution of Profits in Company

Directors of the company are paid remuneration by the company whereas distribution of profits in private limited company is done among the shareholders. Every person who holds the shares of the company is entitled to the profits of the company. Distribution of profits in the company takes place in the form of dividends and are regulated by the Companies Act, 2013.

Dividends are the profits that are not retained but distributed to the shareholders of the company. They are distributed as a percentage of the nominal or face value of the shares of the company. There are two types of dividends that a company can pay to its shareholders. This includes:

  • Interim Dividend: Interim dividend is paid by the company before the annual general meeting and before the financial statements are released.
  • Final Dividend: Final dividend is paid by the company after the end of the financial year as recommended by the board and announced in the general meeting of the company.

The Companies Act, 2013 lays down explicit provisions governing the payment of the dividend from its announcement till final payment. Let’s take a look at the same!

Dividends – The Companies Act, 2013

Following are the provisions in relation to the distribution of dividends in companies covered in the Companies Act, 2013:

  • The dividends shall be paid only out of the current year or previous year’s profits or both or out of the amount provided by the State or Central Government for payment of dividends pursuant to the guarantee undertaken by them.
  • Before declaring the dividends, the company shall transfer certain amounts of profits to the reserves of the company as it may deem fit.
  • The dividend shall be paid only out of the free reserves of the company
  • The dividend shall be declared only after the previous year’s carried-over losses and depreciation has been set off against the profits of the current year.
  • The board of directors can declare the interim dividend after the closure of the financial year till the date of holding the annual general meeting out of either:
    • The surplus in profit and loss account or
    • The profits of the financial year for which the dividend is declared or
    • Profits generated till the quarter preceding the date of declaring the interim dividend
  • If the company has incurred a loss during the financial year up to the quarter preceding the date of declaring the interim dividend, then the rate of interim dividend shall not be higher than the average rate of dividend declared by the company during the immediately preceding 3 financial years.
  • The amount of dividend, including the interim dividend, shall be deposited in a separate bank account in the scheduled bank within 5 days from the date of declaration of the dividend.
  • The dividend should be paid only to the registered shareholder or to his banker or to his order.
  • The amount of dividend that has been declared but remains unclaimed or unpaid within 30 days from the date of declaration of the dividend shall be transferred to a special account known as Unpaid Dividend Account within 7 days after the expiry of such 30 days.
  • The shareholders entitled to such dividend can apply to the company for payment of unclaimed dividend. The amount of dividend that remains unpaid for a period of 7 years from the date of such transfer to the Unpaid Dividend Account shall be transferred to the Investor Education and Protection Fund.

Taxability of Dividends

Dividends are nothing but distribution of profits in company and therefore are taxable in the hands of the shareholders. Earlier, the companies used to pay the Dividend Distribution Tax (DDT) to the government thereby making dividends exempt in the hands of the shareholders. However, DDT and resulting exemption has been removed with effect from 1st April 2020. Therefore, the dividends shall now be taxable in the hands of the shareholders at the tax rate applicable to them.

In a Nutshell

Above was the way in which the profits of the company are distributed among the owners of the company. If you have any doubts about the receipt or taxability of dividends, then feel free to contact your eAuditors.

Author : Dipen

Date     : 01-Sep-2022