Posts

Dividends Denied: Why InvIT SPV CashFlows Don’t Flow Up

/0 Comments/in , /by

Simrat Singh | Finserv@vinodkothari.com

REITs and InvITs are often discussed together as parallel innovations in India’s capital markets, reflecting a push towards deploying capital in real estate and infrastructure. Both frameworks were introduced in 2014, share a trust-based structure and are subject to broadly similar regulatory principles, including mandatory cash distribution requirements and both also have a common tax provision in section 115UA of Income Tax Act, 1961 (section 223 in the 2025 Tax Act). Comparatively, InvITs have witnessed a significantly stronger growth, largely driven by the government’s sustained push towards infrastructure development. The data clearly reflects this divergence. As of April, 2026, there are 6 registered REITs and 28 InvITs in India, managing an AUM of ₹2,50,000 Crores and ₹6,20,000 Crores respectively. Among the InvITs, Road sector InvITs dominate the total AUM. (see our write-up on distribution of AUM of InvITs here). Notable, the national monetisation pipeline 2.0 proposed monetization of approx ₹3,35,000 Crores worth of highway assets under InvIT/TOT models (see our write-up on this here). 

While InvITs are required to distribute 90% of their cash flows, the underlying SPVs, mandated to be in company form, are constrained by dividend distribution rules that rely on accounting profits rather than actual cash generation. In sectors such as roads and power, where assets are finite-life concession rights or long term power purchase agreements, such assets are subject to heavy amortisation which leads to SPVs report book losses despite generating steady cash flows. As a result, cash exists within the SPV but cannot be upstreamed efficiently as dividends. This issue stems from treating InvITs on par with REITs despite differences in investments and nature of assets and from disallowing flexibility in the legal form of SPVs.

Industry workaround has been towards debt-heavy (thin capitalisation) structures, enabling distributions through interest and loan repayments, though these might raise tax issues (discussed below). Beyond such workarounds, more durable solutions are explored in line with international models like US Master Limited Partnerships and Singapore Business Trusts such as permitting dividend declarations based on cash flows rather than accounting profits, reconsidering the mandated company form of SPVs to allow more flexible structures such as trusts or LLPs etc.

Nature of investments by REITs and InvITs

REITs and InvITs are different in the sense that one invests in a property and looks at long term appreciation/rentals. The other looks at an infra asset which gives cash flows only for a certain period

REITs hold income-generating real estate assets with no fixed economic life. These assets can be retained, redeveloped/renovated or replaced over time. At the SPV level, there is no restriction on holding multiple assets and the portfolio of assets can be managed through acquisitions and divestments.

In contrast, InvITs, particularly in the road sector, hold assets that are inherently finite. These assets are in the form of concession rights and are intangible assets where the concessioning authority (usually NHAI) grants a right to operate and collect revenue for a defined period, say 15 to 20 years. Note that the road asset is not the asset that is taken on the balance sheet of the SPV, rather it is the intangible right to collect revenue on the road that is capitalised. At the end of the concession period, the asset reverts back to the concessioning authority, leaving no residual economic value. At this stage, the SPV merely becomes a shell entity, holding in itself only residual litigations or tax demands awaiting its eventual outcome of being wound-up.

Moreover, there are certain constraints imposed by the concession agreement entered into between the SPV and NHAI. Under standard concession agreements, each road project is required to be housed in a separate SPV. Which is why the name of the SPVs are in the style “[Name of Road Stretch] Tollway/Toll Road Private Limited”. The “one project, one SPV” model prevents aggregation of road assets within the same SPV and keeps the rights, obligations and risk allocation clearly demarcated. While this mandatory housing of each project in a separate private limited entity has its advantages, such as lender protection, bankruptcy remoteness and clarity in enforcement of contractual rights, it also creates rigidity for the InvIT. 

The inability to pool assets or recycle assets within the SPVs prevents capital recycling. Unlike REIT SPVs, InvIT SPVs cannot recycle capital either by selling assets or acquiring new ones within the same entity. As a result, while REITs can operate vehicles with a perpetual asset base, InvITs function as portfolios of wasting assets that are depleted over time and cannot be replaced within the same SPV. 

Distribution requirement and the dividend constraint

Both REITs and InvITs (and their SPVs/HoldCos) are required to distribute at least 90% of their net distributable cash flows. This distribution can occur through interest on loan, loan repayment or dividends from the SPVs. The challenge for InvITs arises at the SPV level, in the case of dividend distribution. Under Section 123 of the Companies Act, a company can declare dividends only out of distributable profits or accumulated reserves. The books of such SPVs are loaded with high upfront capitalisation of construction costs and subsequent recognition of a concession asset. This asset is depreciated (or amortised in case of intangible assets such as concession right) over the concession period along with the amortization of the earlier capitalised expenditure, leading to significant non-cash expenses in the profit and loss account which continues to hit the Profit and Loss account even when the SPV starts collecting cash. As a result, even when the SPV generates operating cash flows from toll collections, it remains in ‘book losses’ for a portion of the concession life. The consequence is that such SPV is unable to declare dividend distribution to the InvIT despite the availability of cash.

Depreciation on a non-replaceable asset?

Accounting principles require allocation of asset cost over its useful life. This is conceptually sound for assets that are expected to be replaced or reinvested in. A machinery may be required to be replaced once its useful life is over, therefore, it is only prudent to set aside a part of the cost so there is enough cushion when the entity goes to replace the machinery. 

In the case of REITs, this logic holds good. Depreciation reflects the wear and tear of the replaceable asset and the entity has the ability to reinvest/replace the asset over time (i.e. purchase a new rent yielding building in the same SPV). The economic cycle supports the accounting treatment.

For InvIT SPVs especially in the road sector, the asset is not replaced at the end of its life; it is handed back to the concessioning authority. The SPV has no ability to deploy accumulated depreciation (or amortization in case of an intangible asset) towards acquisition of a new asset. Its economic life is co-terminus with the concession period. This creates a disconnect between accounting profits and economic cash flows. Depreciation suppresses book profits without corresponding economic relevance in terms of asset replacement within the SPV.

International comparisons 

Singapore’s Business Trusts

Singapore offers the clearest analogy to and resolution of this problem. The Business Trusts Act 2004 (BTA), administered by the Monetary Authority of Singapore (MAS), created a hybrid structure that combines features of a company (separate legal personality, professional management) with features of a trust (cash-based distributions). The defining advantage of the Singapore Business Trust (BT) is stated explicitly in the legislation and was articulated in the MAS’s explanatory brief for the Business Trusts (Amendment) Bill 2022:

“A key advantage of a BT structure is the ability of a trust to pay dividends to unitholders out of its cash profits. In contrast, a company can only pay dividends out of its accounting profits (i.e. after deducting non-cash expenses such as depreciation). The BT structure is thus particularly suited to businesses with stable growth and high cash flow.”

Singapore listed 15 Business Trusts as of 2026, covering assets including power generation, toll roads, and shipping. For infrastructure BTs, the cash-based distribution right is central to the investment proposition. Critically, the BT does not interpose a company-form SPV between the trust and the infrastructure asset; the trust itself holds the operational assets. This avoids the Section 123-equivalent constraint that would arise if a company-form subsidiary were the operating entity.

The Singapore model, however, is not directly transplantable to the Indian road sector context for the reason explained above ie NHAI’s requirement for a company-form concessionaire. 

The US Master Limited Partnership Model

In the United States, the Master Limited Partnership (MLP) structure, originally developed for oil and gas pipelines and subsequently applied to other infrastructure sectors, avoids the dividend constraint through the partnership form. Partnerships are not subject to corporate dividend restrictions; distributions to limited partners (akin to unitholders in InvITs) are made based on cash available for distribution, a metric that is equivalent to NDCF and adds back non-cash charges including depreciation and amortisation. Interestingly, MLPs typically grant the General Partner (GP is somewhat analogous to the investment manager in an InvIT), a share in the distributable cash flows through Incentive Distribution Rights (IDRs). These rights are structured on a tiered basis, such that as distributions to Limited Partners increase, the GP becomes entitled to a progressively larger share of incremental cash flows. This creates a performance-linked incentive for the GP to enhance distributable cash. At the same time, the GP retains discretion over the quantum of cash to be distributed versus retained.

Possible approaches

In the original consultation process leading to the introduction of InvITs, SEBI did take note of international structures such as the Master Limited Partnerships in the United States, which allow cash-based distributions without being constrained by law dividend rules. However, there was no discussion on the legal form of the SPV and the final regulations settled on a company structure for underlying entities. Had there been flexibility to allow SPVs to be structured as trusts and/or LLPs, the present issue may not have arisen in the first place.

Thin capitalisation

A commonly adopted workaround is to maintain a thinly capitalised SPV, with the bulk of funding structured as loans from the InvIT rather than equity investment. In such cases, distributions are routed primarily through interest payments and loan repayments instead of dividends, a structure widely used in InvIT arrangements. However, this approach may attract limitations under Section 94B of the Income Tax Act, 1961 (section 177 in the 2025 Act), which operates as a Specific Anti-Avoidance Rule (SAAR) on excessive interest deductions. The provision applies where an Indian borrower incurs interest expenditure exceeding ₹1 crore in respect of debt from a non-resident associated enterprise (or even third-party debt backed by such an enterprise). In such cases, the deduction for interest is restricted to 30% of EBITDA or the actual interest payable to associated enterprises, whichever is lower and any excess interest is disallowed. Accordingly, in InvITs where non-residents usually hold the majority of the units, thin capitalisation may lead to disallowance of interest deductions for SPVs.

Allowing Dividend Declaration Based on NDCF

A more targeted solution would be a targeted regulatory relaxation by the Ministry of Corporate Affairs, permitting dividend declaration by InvIT SPVs based on NDCF rather than accounting profits. This would essentially create a sector-specific carve-out from Section 123’s profit test for companies that are 100% subsidiaries of registered InvITs or HoldCos of InvITs. 

Tweaking the legal form of the SPV

One possible approach is to reconsider the legal form of SPVs. Allowing SPVs to be structured as trusts could align the distribution framework more closely with cash flows rather than accounting profits. However, this would require a shift in regulatory and contractual frameworks as SEBI and NHAI both need to be onboarded on this. This solution seems far-fetched as Road assets vesting in a trust is a scenario which NHAI will not be comfortable with.

Conclusion

The principle is clear: regulation must follow the nature of the asset, not force the asset into an ill-fitting form. To mandate distribution without enabling it is, as in the tale of King Canute, to command the tide to rise while forbidding it a shore. An instruction complete in form, but wanting in effect. India’s InvIT framework is, without a doubt, a notable financial innovation, a bridge that has opened public infrastructure to private capital and supported the National Monetisation Pipeline. But the task is not merely to invite capital but to also ensure that the channels through which it flows are kosher. The present framework, in treating REITs and InvITs as parallel structures, overlooks divergence. While REITs rest on perpetuity of assets, InvITs are built on finite-life concessions that steadily deplete. This mismatch, compounded by accounting norms, contractual structures of NHAI and the Companies Act, creates a distribution bottleneck, where cash is generated but cannot be cleanly upstreamed. Industry has found workarounds, principally by way of intercompany loans. But the issue warrants policy attention. We can take guidance from comparative regimes, such as the Singapore Business Trust framework and U.S. MLPs and recognise infrastructure as a cash-flow distribution business and permit distribution mechanisms that reflect this reality. It is therefore imperative that SEBI, MCA, and NHAI act in concert to resolve this misalignment. Only then can InvITs evolve from a promising innovation into a durable pillar of India’s infrastructure architecture.

See our other resources on InvITs:

  1. InvITs and REITs: Regulatory actions for more enabling environment
  2. PPT on InvITs
  3. Roads to Riches: A snapshot of InvITs in India
  4. CG norms for REITs and InvITs aligned with equity-listed entity

Profit, Prudence and Payouts: New RBI Regulation for Dividends by Banks

/0 Comments/in /by

Dayita Kanodia and Simrat Singh | finserv@vinodkothari.com

RBI on March 10, 2026 issued the Reserve Bank of India (Commercial Banks – Prudential Norms on Declaration of Dividend and Remittances of Profits) Directions, 2026 (‘Dividend Directions’). Earlier, a draft was issued on January 6, 2026 seeking comments from stakeholders. The Dividend Directions replaces the existing directions entirely and introduces concepts like Adjusted PAT, CET1-based dividend bucket framework and prescribes a list of ‘ineligible profits’ for the payment of dividend. 

This article discusses the key changes in the regulatory requirements for the payment of dividends by banks.

Adjusted PAT: A risk-adjusted base for dividend distribution

Dividend has to be paid as a percentage of adjusted PAT. Adjusted PAT is the PAT of the financial year for which the dividend is proposed to be paid minus 50% of Net NPA as on March 31 of the financial year for which the dividend is to be paid. By linking dividend payouts with asset quality, the framework ensures that banks with higher stressed assets retain a larger portion of earnings rather than distributing them as dividends.

Maximum Permissible Dividend Payable

Under the earlier directions, whether a bank could declarate dividend or not depended, inter-alia, on a matrix combining CRAR and NNPA ratios and the maximum dividend payout ratio was capped at 40% of net profit, depending on capital adequacy and asset quality. 

The Dividend Directions replace the earlier CRAR-NNPA based matrix with a CET1 capital ratio bucket framework. Under the new system, banks fall within the various ranges of CET1 capital buckets (10 in total), each prescribing the maximum percentage of dividend that may be declared out of Adjusted PAT. At the same time, the overall dividend distribution is capped at 75% of PAT.

An illustration of the computation of the maximum permissible dividend payable is shown below:

(₹ in crores)
Total Assets500000
PAT3000
Net NPA (NPA – Prov)500
Adjusted PAT (PAT – 50%* NNPA)2,750
CET 1 Capital (end of PY)12%
Dividend allowed (new directions) [max of (30%*Adj. PAT) or (75% of PAT)]825
Dividend allowed (erstwhile directions) (35%*PAT)1050

Ineligible Profits for the payment of dividends

The Directions identify 4 kinds of profits that cannot be used for payment of dividends or remittance of profits:

  1. Extra-ordinary or exceptional profits: banks cannot distribute one-time or abnormal profits. The definition of exceptional profits has to be taken from the applicable accounting standards. Banks will therefore have to ascertain the items which lead to extraordinary profits and exclude them while declaring dividends. Any profits from activities or transactions that are not in the ordinary course of business will therefore have to be excluded. 
  2. Overstatement of PAT flagged by auditor: If the audit report contains a modified opinion indicating overstatement of PAT, the overstated portion cannot be used for dividend payments.
  3. Unrealised gains on level 3 financial instruments: RBI (Commercial Banks – Classification, Valuation and Operation of Investment Portfolio) Directions, 2025 provides that dividends cannot be paid out of net unrealised gains recognised in the Profit and Loss Account arising on fair valuation of Level 3 investments on its Balance Sheet. The same has now been specified under the Dividend Directions as well. 
  4. Reversal of excess provisions or unrealised gains from transfer of loans/ SRs guaranteed by GoI: In terms of the RBI (Commercial Banks – Transfer and Distribution of Credit Risk) Directions, 2025, the non cash component of the excess provision remaining with the bank at the time of transfer (Excess provision minus cash received as consideration for transfer) cannot be used for the payment of dividend. Further, with respect to the SRs guaranteed by the GOI, it has been provided that any unrealised gain recognised in the Profit and Loss Account on account of fair valuation of such SR investments shall be deducted from CET 1 capital, and no dividends can be paid out of such unrealised gains. 

Changes in Eligibility Criteria

The earlier directions required banks to maintain CRAR of at least 9% for the preceding two financial years and the relevant financial year, along with an NNPA ratio below 7%, and permitted dividends only out of current year profits. 

The revised framework removes the NNPA threshold and historical CRAR requirements and instead adopts a simple prudential condition, ie., Banks must be in compliance with regulatory capital requirements and must continue to remain compliant even after the proposed dividend payment. In addition, the bank must have a positive Adjusted PAT for the relevant financial year in which the dividend has to be paid. 

Other Relevant Changes

Board Oversight

The Dividend Directions require the Board to evaluate certain factors before approving the declaration of dividend. In particular, the Board must consider RBI supervisory findings relating to divergence in asset classification and NPA provisioning, the statutory auditor’s report including any modified opinion or emphasis of matter, the bank’s current and projected capital position vis-à-vis regulatory capital requirements and the bank’s long-term growth plans. 

Definition of Dividend

Dividend has been clarified to mean to include interim dividend as well. Further, it shall consider dividend payable on equity shares and excludes dividend on Perpetual Non-Cumulative Preference Shares (PNCPS). Dividend payable on compulsorily convertible preference shares will, however, be included. 

Reporting Mechanism

A bank paying dividend or remitting profits to the head office will be required to report details as per the format prescribed under Annex II of the Dividend Directions. The report is required to be furnished to the DoS within a fortnight of declaration of dividend / remitting profits to head office. Earlier, such a report was required to be furnished to the DoR. 

When “Profit” Isn’t Always Distributable

/0 Comments/in , , , , /by
– Understanding Reportable vs Distributable Profits under Ind AS and the Companies Act, 2013

– Sourish Kundu | corplaw@vinodkothari.com

In the sphere of corporate law intertwined with accounting principles, there arises a question on profits that are reported in the financials of a company and the amount that can actually be distributed, that is to say, a company’s reported profits may be impacted by several accounting standards, yet that does not mean it can distribute all of that profit as dividends. Under Indian law and accounting rules, there is a clear distinction between reportable profits (what appears in the financial statements) and distributable profits (what a company is legally permitted to pay out to shareholders). In this article, we decode the difference between reportable profits and distributable profits and the implications of this difference, whether companies are expected to prepare two statements of profit or loss, how investors are expected to read the financials to ascertain what can be expected as dividend. 

What are Reportable Profits?

“Reportable profits” refers to the profits (or loss) shown in the Statement of Profit & Loss prepared under Indian Accounting Standards (Ind AS). It includes all recognised items of income, expenses, gains and losses, whether realised or unrealised, so long as they meet the recognition and measurement rules in terms of the relevant accounting standards. For example, under Ind AS 109 (Financial Instruments), paragraph 5.7.1 states that changes in fair value of financial assets or liabilities measured at fair value through profit or loss (FVTPL) must be recognised in the PnL. Similarly, fair-value measurement principles under Ind AS 113 (Fair Value Measurement) apply where other Ind ASs require or permit fair value. 

Because reportable profits include unrealised fair value gains, remeasurements, or other accounting adjustments, there is always a possibility of an inflated or deflated picture being painted wherein there is a difference between a company’s “profit” number from the perspective of distribution.

What are Distributable Profits?

“Distributable profits” are that portion of profits (or reserves) out of which a company can legally declare and pay dividends to its shareholders under the Companies Act, 2013. Section 123(1) of the Act states that a company shall not declare or pay any dividend for a financial year except:

  • out of the profits of the company for that year, after providing for depreciation, and
  • out of the profits of any previous financial years, after providing for depreciation and remaining undistributed.

The first proviso to section 123(1) further clarifies that unrealised gains, notional gains or revaluation surplus arising from measurement at fair value shall not be treated as realised profits for the purpose of dividend declaration. 

“Provided that in computing profits any amount representing unrealised gains, notional gains or revaluation of assets and any change in carrying amount of an asset or of a liability on measurement of the asset or the liability at fair value shall be excluded”

Thus, even though accounting standards allow recognition of such gains/losses in the PnL statement, the law restricts their distribution and ensures distribution can be made of only actual realised profits.

As per the section, following adjustments are required to be made to reportable profits to compute distributable profits

Reportable ProfitsXXX
Less:
(b) unrealised gains(XXX)
(c) notional gains(XXX)
(d) revaluation of assets (positive)(XXX)
(e) any change in carrying amount of assets (positive) on measurement at FV(XXX)
(f) any change in carrying amount of liability (reduction) on measurement at FV
Add:
(a) revaluation of assets (negative)XXX
(b) any change in carrying amount of assets (reduction) on measurement at FVXXX
(c) any change in carrying amount of liability (increment) on measurement at FVXXX
Distributable ProfitsXXX

So effectively, it is not the case that companies need to maintain or prepare parallel PnL, one for the accounting purpose and one for the purpose of ascertaining distributable profits, the adjustments as illustrated above needs to be carried out. This is similar to adjustments carried out for the purpose of ascertaining profits in terms of Section 198 of the Companies Act, 2013, which is broadly used for determining CSR expenditure and the limits of managerial remuneration. Interestingly, the treatment of fair value changes in assets and liabilities is akin to how it is treated here, that is, fair value gains are not given credit and hence reversed, and on the other hand, fair value losses are not deducted and hence added back to arrive at the figure out of which managerial remuneration is to be paid, or CSR expenditure is required to be made. 

Some examples of such fair value changes and their impact on the reportable and distributable profit figures are given below: 

Examples: 

Consider the following scenarios for company following Ind AS principles of accounting: 

  1. Treatment of FVTPL
DateParticularsValue Reportable Profits Distributable Profits 
July, 2024Acquisition of investment Rs. 100––
31st March, 2025Value of investments Rs. 15050 (represents fair value gains routed through PnL)–
January, 2026Sale of investments Rs. 200–100 (realised gain)
  1. Deferred Tax Asset
DateParticularsValue Reportable Profits Distributable Profits 
July, 2024Acquisition of investment Rs. 100––
31st March, 2025Value of investments Rs. 70-30 (represents fair value loss routed through PnL)–
Deferred tax assetRs. 9 (30% tax on Rs. 30)9 –
January, 2026Sale of investments Rs. 90–-10

Why the Difference Exists

The divergence arises because accounting standards and company-law provisions serve different purposes:

  • The Ind AS framework aims to present true and fair information about an entity’s financial performance and position, which includes remeasurements and accounting for fair value changes.
  • The company law legislation aims to protect the company’s capital base and ensure dividends are paid out of “real” profits, thereby protecting creditor interests and preventing erosion of capital.

Thus, distributing unrealised or notional gains could expose the company (and its creditors) to risk if those gains reversed. The legal restriction is a form of capital maintenance concept.

Conclusion

In sum: reportable profits (what Ind AS shows) is not always the same as distributable profits (what a company can legally pay out). The presence of items such as unrealised fair-value gains, which are recognised in profit but not “realised” and hence, not available for distribution under company law, creates this difference. Understanding this distinction is essential because in the end, the dividend cheque flows only from the legally distributable pool and not simply from what the profit and loss account might suggest.

Read more:

Should you expect adjustment in profits for “Expected Credit Loss”?

Cash in Hand, But Still a Loss? 

Waiver of dividend by shareholder: Whether generosity can become atrocity?

/0 Comments/in , , , , /by

– Sikha Bansal, Senior Partner and Simrat Singh, Senior Executive | corplaw@vinodkothari.com

Legal basis for dividend entitlement

The right of a shareholder to receive dividends is conferred under Section 123(5) of the Companies Act, 2013 (‘CA, 2013’). The corresponding obligations on the company are elaborated in Chapter VIII of the Act (Sections 123 to 127), read with the Companies (Declaration and Payment of Dividend) Rules, 2014. For listed companies, Regulations 42 and 43 of the Listing Regulations, 2015 further prescribe a few procedural requirements for declaration and payment of dividend.

However, neither the CA, 2013 nor the Listing Regulations, 2015 recognise a shareholder’s unilateral right to waive the dividend declared by the company.

Waiver by a shareholder – whether dependent on other shareholders

Although the statutory framework does not provide for a waiver, the relationship between the company and its shareholders can, to an extent, be governed by a contract, so long as such contract is not ultra vires the CA, 2013. It is a settled position that the Articles of Association (AoA) of a company form a contract between the company and its members and also inter-se among the members (see Naresh Chandra Sanyal v. Calcutta Stock Exchange Association1).

Subject to the provisions of the Companies Act the Company and the members are bound by the provisions contained in the Articles of Association. The Articles regulate the internal management of the Company and define the powers of its officers. They also establish a contract between the Company and the members and between the members inter se. The contract governs the ordinary rights and obligations incidental to membership in the Company

As per the Indian Contract Act, 1872 (‘Contract Act’), a proposal becomes a promise, only when it is accepted by the counterparty. A promise takes the form of an agreement which, if enforceable under law, becomes a contract. Therefore, there has to be assent from both the parties, in order to constitute a contract. Where one party only proposes, and the other does not accept, there is no question of a promise/agreement/contract. 

Further, when a shareholder intends to waive his rights as to dividend – such a dividend foregone can be construed as a gratuitous transfer to the kitty of other shareholders – in essence, a gift. Under the settled principles of common law and as per section 122 of Transfer of Property Act, 1882, a gift is valid only when accepted by the recipient. 

122. “Gift” defined.—“Gift” is the transfer of certain existing moveable or immoveable property made voluntarily and without consideration, by one person, called the donor, to another, called the donee, and accepted by or on behalf of the donee

XX

Therefore, for a waiver to operate as a gift benefiting others, it must be accepted by the general body of shareholders who stand to receive this “gift”. Therefore, without the express consent by other shareholders, a request of waiver of dividend by one shareholder cannot be acceded to.

Binding nature of promises under Contract Law

Section 37 of the Contract Act mandates that parties to a contract must perform or offer to perform their respective promises, unless such performance is excused under the Act or any other applicable law. Where under articles of association, a company agrees to declare and pay the dividend, the shareholders agree to receive the same in accordance with the provisions of the articles. Therefore, once a dividend is declared, the company is under a legal obligation to pay it and the shareholder is obligated to receive it. The shareholder cannot unilaterally waive this right unless such dispensation is as per law. 

Here, it might also be relevant to discuss the peripheries of section 63 of the Contract Act, which provides that a promisee may waive or remit performance wholly or in part. But the spirit of this provision is to release the promisor of an obligation, not to impose an additional burden. In Keshavlal Lallubhai Patel v. Lalbhai Trikumlal Mills Ltd.2 it was held that a promisee may extend the time for the performance of the promise u/s 63 of the Contract Act. However, the promisor may choose not to accept the extended time if it will hamper the performance of his promise. Therefore, a promisor is not bound to accept any waiver of the promisee, he is allowed to weigh-in his/her own interests. 

Therefore, section 63 does not operate without any boundaries.

Implications of unilateral waiver on the company

Dividend declaration is a strategic financial decision taken by the Board after considering multiple factors such as growth strategy, return on equity, share price impact, liquidity needs, and need for reserves. If a company provides this right to one shareholder, it may have to provide the same right to other shareholders. Therefore, a unilateral waiver by a shareholder could distort this delicate balance in several ways, as it may affect the equitable treatment of shareholders and also impact the company’s policy on retained earnings/general reserves. 

Rebutting section 127 concerns

One may argue that Section 127 of the CA, 2013 which allows shareholders to give directions regarding the “manner of payment” of dividend, empowers them to waive their dividend. However, this is a misreading of the provision. Section 127 pertains to mode and timeline of payment, not the right to forgo the dividend altogether. Refusing to entertain a waiver does not constitute a violation of this section.

Closing thoughts

Thus, what appears to be an act of generosity might actually prejudice other shareholders and strain the company’s governance framework. Therefore, in our view, a shareholder seeking waiver of dividends may have a generous intent – however, that cannot happen without the approval of the general body of shareholders.

  1. 1971 AIR 422, AIR 1971 SC 422 ↩︎
  2. 1958 AIR 512 ↩︎

Bye bye to Share Buybacks

/0 Comments/in , , , , , /by

– Finance Bill 2024 puts buybacks to a biting tax proposal w.e.f. 1st October, 2024

-Team Corplaw | corplaw@vinodkothari.com

Among the tax law changes proposed by Finance Bill, 2024, the one on share buybacks, explained as one intended to remove tax inequity, is perhaps the most unexplainable.  The proposed change, by introduction of a new sub-clause (f) to section 2 (22) [deemed dividend], and simultaneous amendments to sec. 46A and sec. 115QA, not only shifts the tax burden from companies to shareholders, but surprisingly, brings to tax the entire amount paid on buyback, irrespective of the excess realised by the shareholder. It  leaves the cost of shares to be claimed as capital loss and set off against potential capital gains, of course only if such gains arise  within the prescribed timelines for carry forward and set off.

Buyback of shares is the only way a company seeks to scale down its capital. The proposed amendment makes it impossible for companies to reduce their capital base by returning capital not needed, as the only other way is through reduction of share capital, which is subject to shareholders’, creditors’, and NCLT approval. It is surprising that this amendment by the very same Budget which proposes to introduce the novel concept of “variable capital companies”.

Read more →

Holding of promoter shares through investment companies: Dividend restrictions clog upstreaming and create tax inefficiency

/0 Comments/in , , /by

Vinod Kothari & Payal Agarwal | corplaw@vinodkothari.com

Most of the promoter holdings in India, in companies large and small, are funneled through group investment companies. These companies, often with a complicated network of cross holdings, were created historically with multiple motives. While shadier motives such as re-routing of black money belong to some decades old practice, there have been multiple other reasons – from lowering of capital gains on holdings by not offering the market value of the listed operating entity, to camouflaging beneficial holdings or defying the definition of “promoter group”, etc etc. In many cases, the division of family holdings among sons or brothers is also done by dedicating an investment company to each such participant. In short, there have existed multiple reasons for networked holdings though layers of investment companies, with natural persons or groups of natural persons (HUFs, family trusts, etc) sitting somewhere at the end of the spectrum.

Over time, these practices have become increasingly unviable, and tough. For example, the possibility of avoiding capital gains tax by disregarding the value of listed stocks at operating company level and transferring the holding entity, which is obviously unlisted, was struck at by the introduction of Rule 11UA of the Income tax Act which requires an “adjusted NAV” computation w.e.f. 1st April, 2017 that takes into consideration the fair value of the investments too. The possibility of garbing the identity of natural persons was further challenged by the introduction of sec. 90 of the Companies Act read with the Significant Beneficial Owners Rules with effect from February, 2019, mandating the disclosure of indirect holdings of significant beneficial owners. Cross-holdings may still avoid classification as a “promoter group” entity, but over a period of time, the sheer burden of compliance by itself outweighs the benefits.

Read more →

An overview of the regulatory framework of dividends

/0 Comments/in , /by

An overview of the regulatory framework of dividends

Other ‘I am the best’ presentations can be viewed here

Our other resources can be accessed here –

  1. https://vinodkothari.com/wp-content/uploads/2020/02/Note-on-declaration-on-interim-dividend_revised-converted.pdf
  2. https://vinodkothari.com/wp-content/uploads/2018/01/Article-on-SS-3.output.pdf
  3. https://vinodkothari.com/2021/06/dividend-restrictions-on-nbfcs/
  4. https://vinodkothari.com/2016/07/faqs-on-dividend-distribution-policy/

Dividend restrictions on NBFCs

/1 Comment/in /by
– Financial Services Division (finserv@vinodkothari.com)

Background

The Reserve Bank of India (RBI) vide a notification dated 24th June, 2021[1] imposed restrictions on distribution of dividends by non-banking financial companies (‘Notification’). The restrictions cover both systemically important NBFCs as well non-systemically important ones. The guidelines have been issued in line with the draft guidelines for the declaration of dividends by NBFC issued in December 2020. Restrictions on dividend payout essentially force financial sector entities to plough back a minimal part of their profits, and therefore, result in creation of a profit conservation. Such restrictions are common in case of financial institutions world-over, and are also imbibed as a part of Basel III capital adequacy requirements. Similar restrictions exist in case of banking entities[2]. In case of NBFCs, such restrictions were proposed by the RBI vide Draft Circular on Declaration of Dividend by NBFCs dated December 9, 2020[3]. Dividend Payout Ratio (DP Ratio) is an important policy measure for companies for shareholder wealth maximisation. A conservative dividend distribution policy ensures churning of profits thereby ensuring organic growth of the net worth, and assisted by leverage, a return on shareholders’ funds higher than what the shareholders can fetch on distributed money. On the other hand, aggressive dividend distribution policy entails that profits be returned to the shareholders as there are less business investment opportunities, thus wealth of shareholders be returned. The foregoing arguments does not encompass stictict dividend payout criteria, but a broad policy objective which organisations seek to achieve. However, in the case of financial institutions like Banks and NBFCs  the motivation of regulators to limit the dividend payout is from the perspective of prudential regulation. The limit on dividend distribution allows regulators to ensure that adequate capital conservation buffers are maintained at all times by the financial institutions. Most NBFCs follow very conservative dividend policies, and based on publicly available data, the DP Ratios of some of the NBFCs for FY 2019-20 are as follows:
  1. Manappuram- 18.86%
  2. Cholamandalam- 12.78%
  3. Bajaj Finserv- 11.93%
  4. Muthoot Finance- 19.91%
  5. Tata Capital Financial Services- 32.96%
  6. DCM Shriram- 17.19%

Applicability

Who all are covered? The opening statement of the Notification provides that the Notification is applicable on all NBFCs regulated by RBI. Further, reference is made to the term ‘Applicable NBFCs’  as defined under the respective RBI Master Directions on NBFC-ND-SI and NBFC-ND-NSI. The concept of Applicable NBFC is relevant to determine the applicability of the provisions of the aforesaid RBI Master Directions. Accordingly, it can be understood that, along with the ‘Applicable NBFCs’, the following categories of NBFCs shall be covered under the ambit of the Notification-
  1. Housing Finance Companies (HFCs),
  2. Core Investment Companies (CICs),
  3. Government NBFCs,
  4. Mortgage Guarantee Companies,
  5. Standalone Primary Dealers (SPDs),
  6. NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  7. NBFC- Account Aggregator (NBFC-AA).
  8. NBFC-D (deposit taking NBFCs)
  9. NBFCs-ND (non-deposit taking NBFCs) (both SI and NSI)
  10. NBFC-Factor (both SI and NSI)
  11. NBFC-MFI (both SI and NSI)
  12. NBFC-IFC (both SI and NSI)
  13. IDF-NBFC
However, it is to be noted that For NBFCs that do not accept public funds and do not have any customer interface no limit has been imposed with regards to the dividend payout ratio. Effective from which financial year? Effective for declaration of dividend from the profits of the financial year ending March 31, 2022 and onwards. Which all dividends are covered? Proposed dividend shall include both dividend on equity shares and compulsorily convertible preference shares. However, other than CCPS, dividends declared on preference shares are not included under the Notification. Note that the issue of bonus shares is, in essence, capitalisation of profits, and therefore, is not affected by the present requirement.

Computation of dividend payout ratio:

Besides the upfront conditionalities such as capital adequacy ratio, leverage ratio, etc., the stance of the present Notification is limitation on dividend payout ratio. Hence, the meaning of the DP ratio becomes important. The Notification defines the same as : ‘the ratio between the amount of the dividend payable in a year and the net profit as per the audited financial statements for the financial year for which the dividend is proposed.’ As we discussed elsewhere, the word “dividend” shall be restricted to only equity and CCPS dividend. Hence, dividend on redeemable preference shares shall be excluded. Also note that the word “profit for the year” refers to profits after tax. There is no question of adding the brought forward profits of earlier years, whether parked in reserves or retained as surplus in the profit and loss account. In case of companies adopting IndAS, there are always questions on what constitutes distributable profits – whether the gains or losses on fair valuation, taken to P/L are a part of the distributable profits or not. The relevant provisions of the Companies Act, viz., proviso to sec. 123 (1) shall have to be borne in mind.

Eligibility Requirement and Quantum Restrictions

Category Eligibility Requirement Quantum*
NBFCs (including SDPs) meeting prudential requirements ●  Complies with applicable regulatory capital adequacy requirements/leverage restrictions/Adjusted net-worth for each of the last three financial years including the financial year for which the dividend is proposed

○ For SPDs, minimum CRAR of 20% to be maintained for the financial year for which dividend is proposed.

● Net NPA ratio shall be less than 6% in each of the last three years, including as at the close of the financial year for which dividend is proposed to be declared.

○ Calculation of NNPA

● Complies with the provisions of Section 45 IC of the RBI Act/ Section 29 C of the NHB Act, as the case may be, that is to say, has transferred 20% of its net profits to the regulatory reserve fund ● No explicit restrictions placed by the regulator on declaration of dividend		 ●  Type I NBFCs- No limit●  CICs and SPDs- 60% ●  Other NBFCs- 50%
NBFCs (other than SPDs) not meeting prudential requirements ● Complies with the applicable capital adequacy requirements/ leverage restrictions in the financial year for which dividend is proposed to be paid● Has net NPA of less than 4% as at the close of the financial year. 10%
As regards NBFC-ND-NSI, the applicable regulatory capital requirement, as mentioned in Annex I[4] of the Notification,  seems to suggest that if there is a breach of leverage ratio at any time since 2015, the NBFC is disqualified. This however, does not seem to be the intent of the regulator. The meaning of the aforesaid restriction should be that the provision became applicable from 2015; however, it should not be leading to a conclusion that a dividend distribution will ensure that there is no breach of leverage ratio at any time in the history of the said NBFC. We are of the view that each of the ratios (CRAR or Leverage of Adjusted Net worth, as the case may be) need to be observed ideally at the time of distribution (last three FYs including the year for which dividend is declared), and even conservatively, during the year in question. *The Notification has prescribed the same limits on quantum for a certain class of NBFCs, however, the draft guidelines had prescribed the limits based on the CRAR or adjusted net-worth of the NBFCs. (Refer Annex I of draft guidelines)

Reporting Requirements

NBFC-D, NBFC-ND-SIs, HFCs & CICs declaring dividend shall report details of dividend declared during the financial year as per the prescribed format within a fortnight after declaration of dividend to the Regional Office of the RBI/Department of Supervision of NHB, as the case may be. There seems to be a lack of clarity w.r.t. the disclosure requirement for NBFC-MFIs and NBFC-IDFs. Though they are covered under the definition of ‘Applicable NBFCs’ under the RBI Master Directions, however, they are not generally classified as NBFC-ND-SI. Hence, whether the disclosure requirement is applicable to them or not seems to create confusion. In our view, going by prudence, this must be adhered to by such systemically important MFI and IDFs as well. Accordingly, it can be inferred that the disclosure requirements shall not be applicable to following:
  • Mortgage Guarantee Companies,
  • Standalone Primary Dealers (SPDs),
  • NBFC-Peer to Peer Lending Platform (NBFC-P2P)
  • NBFC- Account Aggregator (NBFC-AA).
  • NBFCs-ND-NSIs

Comparison with the dividend regulations on Banks

Criteria Bank NBFCs
Eligibility Only those banks would be eligible to declare dividends who have a CRAR of at least 9% for preceding two completed financial years and the accounting year for which it proposes to declare dividend and Net NPA less than 7% NBFC-ND-NSI with leverage upto 7 times and NBFC-ND-SI with a CRAR of not less than 15% for last three years (including the FY for which dividend is declared) and Net NPA less than 6% in each of the last three years
In case not meeting eligibility In case any bank does not meet the above CRAR norm, but has a CRAR of at least 9% for the accounting year for which it proposes to declare dividend, it would be eligible to declare dividend provided its Net NPA ratio is less than 5% In case any NBFC does not meet the above eligibility criteria for each of the previous three FY, but meets the capital adequacy for the accounting year, for which it proposes to declare dividend and has a Net NPA ratio of less than 4% at the close of the FY, it shall be allowed to declare dividend, subject to a maximum of 10% on the DP ratio.
Quantum Dividend payout ratio shall not exceed 40 % and shall be as per the prescribed matrix CIC’s and SPDs shall ensure the maximum dividend payout ratio does not exceed 60%, while the other NBFCs shall not exceed 50% of the DP ratio. For Type I NBFCs there is no limit.
Reporting All banks declaring dividends should report details of dividend declared during the accounting year as per the proforma furnished by RBI NBFC-Ds, NBFC-ND-SIs, HFCs & CICs declaring dividend should report the details of dividend within a fortnight after declaration of dividend to RBI/NHB, as may be applicable.

Immediate Actionables

NBFCs, who already have a Dividend Distribution Policy in place, may have to amend the policy in line with the Notification. As per SEBI LODR Regulations, top 1000 listed companies are mandatorily required to have a dividend distribution policy.  Further, NBFCs may also have voluntarily adopted a policy. The dividend distribution policy includes the following parameters:
  • the circumstances under which the shareholders may or may not expect dividend;
  • the financial parameters that shall be considered while declaring dividend;
  • internal and external factors that shall be considered for declaration of dividend;
  • policy as to how the retained earnings shall be utilized; and
  • parameters that shall be adopted with regard to various classes of shares
The eligibility requirements and limits on quantum of dividend, as provided in the Notification,  may be additional criterias for such NBFCs to declare dividend. In such a case, the existing dividend distribution policy shall be required to be amended in order to include the additional parameters. It is noteworthy here that, as per regulation 43A of the LODR, if a listed entity proposes to amend its dividend distribution policy, it shall disclose the changes along with the rationale for the same in its annual report and on its website. [1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12118&Mode=0 [2] https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=2240&fn=2&Mode=0 and other associated circulars [3] https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=50777 [4] https://rbidocs.rbi.org.in/rdocs/content/pdfs/NBFCS24062021_A1.pdf Our related write-ups:
FAQs on Dividend Distribution Policy
Our presentation on dividends – https://vinodkothari.com/2021/09/an-overview-of-the-regulatory-framework-of-dividends/ Watch our YouTube video on Restrictions on dividend distribution on NBFCs