A rupee earned two layers down, and what reaches the top

The presentation leads on two figures: ₹1,240 crore of cash and bank balances, and ₹1,000 crore of free cash flow. At the annual general meeting a shareholder asks why the dividend has not been raised in three years. The answer given is that resources are being conserved for growth, which is the answer always given, and in this case it is not the binding constraint. The binding constraint is that the company whose shares that shareholder owns — the parent, the listed entity, the only one with a price on a screen — earned very little of that ₹1,000 crore itself. Most of the cash is somewhere else in the group, and each place it sits has a different reason why it cannot simply be moved.

Think of it like this

The prosperous family, and Tuesday

A family is prosperous on paper. The shop's float is with the second son. The fixed deposit is lien-marked against a locker facility at the bank. The plot in the village is in a cousin's name because that was convenient in 1998. Everybody agrees on what the family is worth. On the Tuesday the eldest needs eleven lakh for a hospital admission, none of that matters. What matters is whose account it is in, who has to agree, what each of them loses by handing it over, and how long the bank takes.

In the market

A consolidated balance sheet is the family total. Your shares are in one member of the family. Consolidation was designed to tell you what the group is worth and it does that honestly. It was not designed to tell you what the entity you own can pay you, and it does not.

Where the ₹1,240 crore actually is

Where it sits	How much	What it takes to reach the parent
At the parent and its wholly owned Indian subsidiaries	₹310 cr	Nothing, at the parent itself. From a wholly owned subsidiary, a dividend or the repayment of an intra-group loan, with nothing leaking to anybody outside the group — but note that the distributable-profits test below applies to a wholly owned subsidiary exactly as it does to any other, so full ownership removes the leakage and not the gate
Margin money and lien-marked deposits	₹150 cr	Nothing moves it. It is held against bank guarantees and letters of credit and is released when the underlying obligation is discharged. This is restricted cash, and the note says so
Held in escrow under a contract	₹90 cr	Released on the event the contract specifies, to whoever the contract specifies. The company's wishes are not an input
In a 60%-owned listed subsidiary	₹430 cr	A dividend — of which forty paise in the rupee goes to that subsidiary's other shareholders and does not come back — and only if that subsidiary has distributable profits of its own
In an overseas subsidiary	₹260 cr	A dividend, less whatever the source country withholds, with the receipt taxable in India and credit for the foreign tax available under the treaty. The timing is the company's choice; the leakage is not

Careful

What that does to net debt. Borrowings are ₹3,000 crore, so every screener carries net debt of ₹1,760 crore. Strike out the ₹240 crore that is legally encumbered and it is ₹2,000 crore. Ask the sharper question — what could reach the parent's own obligations without leaking to anybody outside the group — and the answer is on the order of ₹310 crore, the parent's own balances plus what its wholly owned subsidiaries can send up, against the ₹1,900 crore borrowed at the parent, the remaining ₹1,100 crore being non-recourse project debt in a subsidiary whose lender can look only to that project. Netting that ₹1,100 crore against cash held anywhere else in the group is meaningless in both directions: the lender cannot reach the cash, and the cash cannot be relieved by that debt going away. Identifying which cash to strike out is the first step of the twelve-month liquidity test earlier in this track. This lesson is the other half of it — what it takes to move the cash that survives the striking out.

The four gates

What a rupee passes through on the way up

1
The paying company must have profits of its own to distribute
A dividend comes out of the current year's profits after providing for depreciation, or out of profits of earlier years that remain undistributed, or both — and the Companies Act itself requires carried-forward losses, and depreciation not provided in earlier years, to be set off against the current year's profit before any dividend is declared. The test is applied entity by entity, to the accounts of the company writing the cheque. Consolidated profit has nothing to do with it. So a subsidiary can be sitting on cash it is not permitted to distribute, which is the single most surprising sentence in this module and the one that most often explains a stagnant dividend at a profitable group.
2
Every other shareholder in the chain takes their share
A dividend is paid on all the shares. Out of a 60%-owned subsidiary, sixty paise in the rupee reaches the parent. Through two layers held 70% and 80%, fifty-six paise reaches the top. Nothing is lost to you in this — the rest was never yours — but it is the reason the parent's dividend capacity is not the group's cash flow, and the reason a group generating its cash in its most heavily diluted subsidiary is a different proposition from one generating it in a wholly owned arm.
3
The tax system takes a view, and the relief depends on passing it on
A dividend received by an Indian company from another Indian company is taxable in its hands. Against it, the receiving company may deduct the dividend it distributes to its own shareholders, up to the amount received, provided it distributes within the period the law prescribes. So a parent that passes the cash straight through is not taxed on it twice; a parent that receives it and retains it is taxed at its own rate. The same deduction is available against a dividend received from a foreign company, so the difference across a border is not a second Indian layer but the tax the source country withholds, against which credit is available under the treaty. The leakage is a function of the route, not of how well the business did.
4
The lenders may have agreed something else
Covenants routinely restrict distributions and upstreaming while a facility is outstanding, and project debt typically permits a distribution only after a debt service reserve is funded and coverage tests are met on a test date. This is the gate that is invisible from the outside unless you read the note on borrowings, and it is the gate that removes itself on a known date: a project loan repaid is a restriction lifted, and the repayment schedule is disclosed.

When a dividend is not available

Repayment of an intra-group loan. Where the parent funded the subsidiary with debt rather than equity, cash returns as repayment of principal: no distributable-profits test, nothing leaking to the subsidiary's other shareholders, and no tax on the principal. A great deal of Indian group funding is structured as loans for exactly this reason, and the loans given and repaid are in the related-party note.
Interest, royalty or a management fee. A charge for something genuinely provided is deductible at the subsidiary and income at the parent, and it moves cash without a dividend. It is also a related-party transaction carrying the approvals and disclosure the listing rules attach — and where the subsidiary has other shareholders, a fee is the mechanism by which value is most easily moved away from them, which is why those approvals exist.
A buyback by the subsidiary, or a reduction of its capital. Both are real routes and both are slow. A reduction of capital requires a tribunal, and a buyback has its own conditions and its own tax treatment in the recipient's hands.
Selling the subsidiary, or a slice of it. This converts the problem rather than solving it: the cash arrives at the parent, the earnings leave the group, and if control is lost the accounts change shape in the way the first lesson of this module describes.
Statutory limits on lending sideways and upwards. An Indian company cannot lend or invest freely within its own group. Beyond limits computed from its own capital and reserves a special resolution is required, and loans to entities in which its directors are interested carry further restrictions. The mechanism to remember is that the subsidiary's board cannot simply hand the money over because the parent asked.

Worked example

What ₹200 crore of dividend at the subsidiary is worth at the top

The 60%-owned listed subsidiary in the table above

Cash held at the subsidiaryUnencumbered, in its own bank accounts, and consolidated into the ₹1,240 crore the presentation quotes₹430 cr

Losses carried forward at the subsidiaryTwo bad years in the middle of the last decade. They sit in its own accounts and are invisible in the group's₹300 cr

This year's profit at the subsidiaryEnough to absorb the carried-forward losses, and only just₹340 cr

What it may therefore distributeDistributable profits are set by its own profits and reserves with the carried-forward losses absorbed first, not by its bank balance and not by the group's profit. The precise figure is a computation for the company and its auditors; the point for a reader is which inputs it usesA fraction of the ₹430 cr of cash it holds

Suppose a later year permits ₹200 crOn all the shares, because a dividend cannot be paid selectively to one shareholder₹200 cr declared

What reaches the parentSixty per cent. The other ₹80 crore goes to the subsidiary's public shareholders. Nothing is lost — that 40% was never the parent's — but the parent's dividend capacity is ₹120 crore, not ₹200 crore₹120 cr

Tax at the parent on the ₹120 crThe deduction for a dividend distributed against a dividend received, capped at the amount received and conditional on distributing within the prescribed period. Retain it instead and the deduction is unavailable and the receipt is taxed at the parent's own rateNil to the extent it is passed on in time

The parent's own dividend capacityThis is the figure to hold against the ₹1,000 crore of consolidated free cash flow on the first slideIts own distributable profits, plus what has actually arrived

The group generated ₹1,000 crore. The listed entity could distribute a fraction of it, and the size of the fraction is set by four things that say nothing at all about the quality of the business: which company earned the cash, whether that company has distributable profits of its own, who else owns shares in it, and what its lenders have agreed. This is also the mechanism underneath the holding-company discount taught elsewhere in this track. That lesson says the discount is a rational price for value you cannot access; this is the arithmetic of why you cannot — and, read forwards, it is the arithmetic that tells you when a discount has a reason to narrow. A subsidiary that has just finished absorbing its carried-forward losses, or a project loan about to reach its final instalment, is a gate about to open — on a date that was disclosed years in advance and is nobody's forecast.

In the Indian market

Four checks, all from documents already published. One: in the parent's standalone accounts, the dividend income line — five years of it against five years of consolidated operating cash flow tells you how much of the group's cash has ever actually travelled. Two: the standalone profit and reserves, which are the dividend constraint, and the one purpose for which the standalone accounts are the right set rather than the wrong one. Three: Form AOC-1, which gives each subsidiary's profit and net worth, so the entity holding negative reserves can be identified by name. Four: where a subsidiary is itself listed, its own annual report states its distributable position and its dividend policy directly, and its own minority shareholders have every reason to want that cash distributed rather than lent upwards.

◆ Your call

A group with ₹1,240 crore of cash proposes a rights issue

The group above announces a rights issue to fund a new plant at the parent. The consolidated balance sheet shows ₹1,240 crore of cash. A message on a forum asks the obvious question: why raise money from shareholders when the company is sitting on more than a thousand crore?

◆ Checkpoint

Module checkpoint: the group, and whose numbers they are

5 questions. Answers are revealed once you submit all of them.

1.A company that already held 49% of another buys a further 2% and obtains control. Its consolidated revenue for the following full year is 45% higher. What has happened?

2.A company's 50%-owned joint venture has ₹1,800 crore of borrowings, and the company has guaranteed ₹900 crore of them. Where does each of those figures appear in the company's consolidated accounts?

3.A group buys out the 45% minority shareholders of a subsidiary it already controls, paying ₹2,600 crore in cash raised as debt against a non-controlling interest carried in equity at ₹1,300 crore. Earnings per share rises 17%. What else has happened?

4.A subsidiary holds ₹430 crore of cash and has ₹300 crore of losses carried forward. The parent wants that cash in order to raise its own dividend. What is the position?

5.Two companies each hold a 50% interest in a jointly controlled activity of similar size. One shows a single line of profit; the other shows a share of the revenue, the assets and the borrowings. Is one of them wrong?

0 of 5 answered

Simple bhasha mein

Paisa hai, par kiski jeb mein

Presentation mein ek number: consolidated cash ₹1,240 crore. Andar: ₹150 crore bank guarantee ke against margin (hilta hi nahi), ₹90 crore escrow mein, ₹430 crore 60% wali subsidiary mein, ₹260 crore videsh mein — aur parent plus uski 100% wali subsidiaries ke paas sirf ₹310 crore, jabki parent par apna ₹1,900 crore ka karza hai. Subsidiary ₹200 crore dividend de to parent tak ₹120 crore (60%); baaki ₹80 crore uske public shareholders ka, aur woh wapas nahi aata. Aapka woh tha bhi nahi — par parent ki dividend dene ki taakat 120 hai, 200 nahi. Aur agar us subsidiary ke ₹300 crore purane nuksaan pade hain? Pehle woh set off honge, tab dividend — ₹430 crore cash hote hue bhi. Isliye "₹1,000 crore free cash flow" aur "dividend kab badhega" do alag sawaal hain.

What to remember

Consolidated cash tells you what the group holds; it does not tell you what the listed entity can spend or distribute.
Four gates stand between a rupee earned in a subsidiary and the parent: distributable profits at that subsidiary, the other shareholders' share, tax on the receipt, and the lenders' consent.
A subsidiary with carried-forward losses can hold cash it is not permitted to distribute, however profitable the group is.
Repaying an intra-group loan bypasses the distributable-profits test and the leakage entirely, which is why so much group funding is structured as debt.
Non-recourse debt in one entity cannot be netted against cash in another, in either direction — and a project loan repaid is a restriction lifted on a date disclosed in advance.

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