Company Law | Declaration & Payment of Dividend | Class Notes
COMPANY LAW
Class Explanation Notes
Declaration & Payment of Dividend
Under the Companies Act, 2013 · Sections 123, 124 & 127
MS Ramaiah College of Law | BBA LLB(B), VI Semester
Prepared for classroom instruction and student reference
CONTENTS AT A GLANCE
I. What Is a Dividend?
II. Why Does Dividend Regulation Matter?
III. Types of Dividend — Final vs. Interim
IV. Sources from Which Dividend May Be Paid
V. Full Step-by-Step Procedure: Final Dividend
VI. Procedure for Interim Dividend
VII. Unpaid Dividend — What Happens Next?
VIII. Penalties & Consequences of Default
IX. Key Legal Provisions — Sections 123, 124 & 127
X. Quick-Reference Summary Table
XI. Examiner's Notes & Common Questions
I. What Is a Dividend?
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Company Law | Declaration & Payment of Dividend | Class Notes
Imagine you invested your savings in a company by buying its shares. The company works hard, earns
profits — and at the end of the year, it decides to share some of those profits back with you. That share of
profits you receive is called a dividend.
In technical terms:
Definition: A dividend is the portion of a company's profits that is distributed among its shareholders,
in proportion to the number of shares held by each shareholder.
For example, if a company declares a dividend of ₹5 per share and you hold 1,000 shares, you receive
₹5,000 as dividend income.
The Legal Basis
Under Section 123 of the Companies Act, 2013, a company may declare dividend only out of its profits or
free reserves. This is the cornerstone rule — a company cannot invent money to pay dividend; it must come
from genuine earnings.
Key Rule — Section 123: A company shall not declare dividend unless it has set aside the requisite
depreciation for the relevant financial year. Dividend cannot, under any circumstances, be paid out of
the company's capital.
Why Dividend Matters to a Shareholder
Shareholders take on risk by investing in a company. Dividend is their reward for that risk. It is also a signal
of financial health — a company that consistently pays dividend is generally seen as stable and profitable.
The law regulates dividends carefully to ensure that management cannot manipulate or delay payments
that rightfully belong to shareholders.
II. Why Does Dividend Regulation Matter?
One might ask: if a company wants to share profits with its shareholders, why does law need to regulate it?
The answer has several dimensions.
▸ Protection of Shareholders: Without regulation, management could withhold profits indefinitely or
divert them unfairly. The law ensures shareholders receive what they are entitled to.
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▸ Protection of Creditors: A company must first meet its debt obligations and provide for depreciation
before declaring dividend. This ensures that paying dividend does not damage the company's ability
to pay creditors.
▸ Prevention of Capital Erosion: If companies paid dividend out of capital, they would be returning the
investors' own money under the label of 'profit,' which is deceptive and financially dangerous.
▸ Financial Discipline: Mandatory timelines and separate bank accounts for dividend prevent
misappropriation of funds meant for shareholders.
III. Types of Dividend — Final vs. Interim
There are two main types of dividend under the Companies Act, 2013. Understanding the difference is
important because the authority to declare each type, the process, and the consequences differ
significantly.
📋 FINAL DIVIDEND ⚡ INTERIM DIVIDEND
Declared at the end of the financial year. Declared during the financial year, between two
AGMs.
Recommended by the Board of Directors. Declared directly by the Board of Directors — no
AGM needed.
Approved by shareholders at the Annual General Board passes a resolution at a Board Meeting.
Meeting (AGM) by Ordinary Resolution. Shareholders do not vote on this.
Based on full-year profits after audit. Based on profits up to the end of the quarter
preceding declaration.
Amount is final and cannot be increased by Rate is capped if the company is running at a loss
shareholders (they may reduce it). — cannot exceed average of last 3 years.
More common and expected by investors. Used when company has surplus mid-year and
wants to reward shareholders early.
Teacher's Tip: Students often confuse who has the authority to declare each type. Remember — Final
dividend is declared by shareholders (at AGM). Interim dividend is declared by the Board alone. This is
a favourite exam distinction.
IV. Sources from Which Dividend May Be Paid
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Company Law | Declaration & Payment of Dividend | Class Notes
The Companies Act, 2013 is very specific about where a company can draw funds to pay dividends. There
are only three permissible sources. All three are grounded in the principle that dividend must come from
genuine economic value, never from the company's core capital base.
Source 1 — Profits of the Current Financial Year
The most straightforward and common source. After the accounts for the financial year are finalised, the
company calculates its net profits for that year. Before declaring dividend from these profits, the company
must mandatorily set aside depreciation for the year as per Schedule II of the Companies Act, 2013.
Think of it this way: if a company owns machinery worth ₹50 lakh, that machinery loses value each year
due to wear and tear (depreciation). The law requires the company to account for that lost value first, and
only then declare dividend from what remains.
Source 2 — Accumulated Profits / Free Reserves
A company may also pay dividend from profits accumulated in previous years that were retained in the
business rather than distributed. These are called 'free reserves' — money that has no specific earmarked
purpose.
This source is particularly important during years when the current year's profits are insufficient to support
a dividend. The Companies (Declaration and Payment of Dividend) Rules, 2014 prescribe specific conditions
for drawing from reserves, including a cap on the amount that can be so used.
Source 3 — Government Guarantee Funds
In certain cases, the Central Government or a State Government may provide money to a company in
pursuance of a guarantee. Dividend may be declared and paid from such government-provided funds. This
is relatively rare and applies mainly to government-aided or public sector undertakings.
❌ What is NOT a valid source? Capital. Dividend CANNOT be paid out of the company's share capital,
securities premium, or any other capital account. This is an absolute prohibition under Section 123.
Paying dividend out of capital is tantamount to returning shareholders' own investment as fake profit
— it is both deceptive and illegal.
V. Step-by-Step Procedure: Declaration of Final Dividend
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Company Law | Declaration & Payment of Dividend | Class Notes
The procedure for declaring a final dividend is a carefully sequenced legal process. Each step must be
completed in the correct order. Let us walk through it as though you are the company secretary managing
the process.
Board Meeting — Examination of Accounts & Recommendation
The first step takes place at a duly convened Board Meeting. The Board of Directors reviews the
audited financial statements for the financial year. They examine the available distributable
profits, assess the company's financial position, and decide whether it is prudent to declare a
01 dividend. If the Board decides to recommend a dividend, they pass a resolution recommending
a specific rate or amount per share. Crucially, the Board only 'recommends' — the final
authority lies with the shareholders. The Board may also decide to transfer a portion of profits
to reserves before making the recommendation.
Transfer to Reserves (Optional but Prudent)
Before the dividend is declared, the company may transfer a portion of its profits to its general
reserve or any specific reserve. This step is entirely optional — there is no mandatory minimum
02 transfer to reserves under the current Companies Act, 2013 (the old requirement was
removed). However, companies often do this as a matter of prudent financial management and
to maintain a buffer for future obligations. This transfer must happen before the dividend is
formally proposed to shareholders.
Notice of Annual General Meeting (AGM)
Once the Board has made its recommendation, the company issues a notice convening the
Annual General Meeting. The declaration of dividend must be specifically mentioned as an
03 agenda item in this notice. The notice must be sent to all shareholders, directors, and other
entitled persons. The prescribed notice period under Section 101 of the Companies Act, 2013 is
generally 21 clear days (though this can be shorter with shareholder consent). The notice must
clearly state the recommended dividend rate.
Declaration at the Annual General Meeting (AGM)
At the AGM, the shareholders consider the Board's recommendation. They pass an Ordinary
Resolution to approve the dividend. A vital legal rule applies here: shareholders can approve
04 the dividend at the recommended rate, or reduce it — but they CANNOT increase the rate
above what the Board has recommended. This protects the company from pressure to pay out
more than is financially prudent. Once the resolution is passed, the dividend is formally
'declared' and becomes a debt owed by the company to its shareholders.
Deposit in Separate Bank Account — Within 5 Days
Within 5 days of the declaration (i.e., within 5 days of the AGM resolution), the company must
deposit the entire amount of dividend in a separate scheduled bank account. This account must
05 be exclusively for dividend purposes — it cannot be mixed with the company's general
operating funds. This rule is designed to protect shareholders: once the money is in this
dedicated account, it cannot be diverted for other corporate uses. The account is often called
the 'Dividend Account' or 'Unpaid Dividend Account' at this stage.
06 Payment of Dividend — Within 30 Days
The actual payment to shareholders must be completed within 30 days from the date of
declaration. Payment can be made through: (a) Cheque sent by post; (b) Dividend Warrant; (c)
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Electronic transfer via NEFT, RTGS, or direct credit to the shareholder's registered bank account;
or (d) Any other RBI-approved banking channel. Most modern companies use electronic
transfer as it is faster, cheaper, and traceable. The company must maintain proper records of all
payments made.
Class Analogy: Think of this process like a waterfall. The Board examines the profits (top of the
waterfall) and decides how much to share. The water flows down through the AGM (shareholders
approve), then into a special bucket (separate bank account), and finally reaches the shareholders
(payment within 30 days). If the water gets stuck in any of these stages, the law penalises the
company.
VI. Procedure for Interim Dividend
Interim dividend is simpler to declare because it does not require an AGM. However, the law places
important safeguards, particularly around the verification of profits and a cap on the rate when the
company is running at a loss.
Step 1 — Convene a Board Meeting
The Board of Directors calls a Board Meeting and passes a resolution declaring interim dividend. The
resolution specifies the rate per share and the record date (i.e., the cut-off date by which a shareholder
must be on the register to receive the dividend).
Step 2 — Verify Profits for the Relevant Quarter
Before declaring interim dividend, the company must verify its profits up to the end of the quarter
immediately preceding the declaration. This is to ensure that the dividend is being paid from actual profits,
not from anticipated or projected profits that may never materialise. The management accounts or
provisional financials for that quarter are examined.
Step 3 — Apply the Loss-Year Rate Cap (If Applicable)
This is the most important and frequently examined rule regarding interim dividend. If the company has
incurred a net loss during the current financial year up to the end of the preceding quarter, the Board
cannot declare interim dividend at any rate it likes. Instead, the rate of interim dividend cannot exceed the
average rate of dividend declared by the company in the immediately preceding three financial years.
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Company Law | Declaration & Payment of Dividend | Class Notes
Example: Suppose a company declared dividends of 10%, 12%, and 8% in the previous three years.
The average is (10+12+8)/3 = 10%. If the company is currently running at a loss, interim dividend for
this year cannot exceed 10%, even if the Board wants to declare more.
This cap protects the company's financial stability and prevents management from declaring generous
interim dividends to win shareholder favour even when the company is losing money.
Step 4 — Deposit & Payment (Same Timelines Apply)
The same timelines that govern final dividend apply to interim dividend: deposit in a separate bank account
within 5 days of the Board resolution, and pay out within 30 days from the date of declaration.
VII. Unpaid Dividend — What Happens Next?
Despite best efforts, some dividend amounts go unclaimed. Shareholders may have changed addresses, not
updated their bank details, or simply forgotten to collect their dividend. The Companies Act, 2013 has a
detailed mechanism under Section 124 to handle such situations in a transparent and traceable manner.
Stage 1 — The 30-Day Window
As established, dividend must be paid within 30 days of declaration. Any dividend that remains unclaimed
or unpaid at the end of 30 days enters the 'unpaid' category.
Stage 2 — Transfer to Unpaid Dividend Account (Within 7 Days)
Within 7 days after the expiry of the 30-day payment period, the company must transfer all unpaid
dividend amounts to a special account called the 'Unpaid Dividend Account.' This account must be opened
in a scheduled bank. The money in this account belongs to the shareholders — the company cannot use it
for any other purpose.
Website Disclosure: The company is also required to place a statement containing the names and
addresses of shareholders to whom unpaid dividend relates on its official website. This enables
shareholders to check whether they have any unclaimed dividend.
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Company Law | Declaration & Payment of Dividend | Class Notes
Stage 3 — Transfer to IEPF After 7 Years
If the dividend remains unclaimed even from the Unpaid Dividend Account for 7 years from the date of
transfer, the company must transfer the amount to the Investor Education and Protection Fund (IEPF),
administered by the IEPF Authority under the Ministry of Corporate Affairs.
Importantly, shareholders do not permanently lose their money. They can file a claim with the IEPF
Authority to recover their dividend even after it has been transferred. However, the process involves
paperwork and time, so it is always better for shareholders to claim their dividend promptly.
Deadline Action Required Details
Day 0 Dividend Declared AGM resolution passed / Board resolution for interim
Within 5 days Deposit in Bank Account Entire amount in separate scheduled bank account
Within 30 Payment to Shareholders By cheque, warrant, or electronic transfer
days
Within 7 days Transfer to Unpaid If unclaimed after 30 days — move to special account
of Day 30 Dividend A/c
After 7 years Transfer to IEPF Government fund — shareholders can still reclaim
VIII. Penalties & Consequences of Default
Section 127 of the Companies Act, 2013 prescribes strict penalties where a company fails to pay dividend
within the prescribed 30-day period. The law takes this seriously because unpaid dividend is essentially a
debt owed to shareholders — delay is a breach of a legal obligation.
Penalty 1 — Interest on Delayed Dividend
The company becomes liable to pay interest at the rate of 18% per annum on the amount of unpaid
dividend for every day the delay continues after the 30-day deadline. This interest accrues daily and is
payable to the shareholders, not to the government.
Penalty 2 — Fine on the Company
In addition to interest, the company itself is liable to pay a fine of not less than ₹1,000 and up to ₹10,000
per day for each day of default while the default continues. This is a continuing penalty — the clock keeps
running until the dividend is actually paid.
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Company Law | Declaration & Payment of Dividend | Class Notes
Penalty 3 — Punishment for Officers in Default
Every director who is knowingly a party to the default, and every officer of the company who is in default, is
punishable with simple imprisonment for a term which may extend to two years and shall also be liable to
pay a fine of ₹1,000 per day for the period during which the default continues.
Exception to Penalty: No penalty applies if the failure to pay dividend is due to: (a) a dispute about the
right of the shareholder to receive the dividend, (b) a legal mandate such as a court order staying the
payment, (c) circumstances beyond the company's reasonable control. Honest operational delays
caused by regulatory or banking issues may be taken into account by the court.
The severity of these penalties reflects a clear legislative policy: a company should not treat dividend
distribution as an optional or flexible obligation. Once declared, dividend is a statutory debt and must be
paid promptly.
IX. Key Legal Provisions at a Glance
Section Short Title What It Covers
§ 123 Declaration of Dividend Permitted sources of dividend (profits, reserves,
government guarantee); depreciation requirement before
declaration; prohibition on dividend from capital;
procedure for declaration.
§ 124 Unpaid Dividend Account Obligation to open a separate Unpaid Dividend Account; 7-
day timeline for transfer; website disclosure of unclaimed
shareholders; transfer to IEPF after 7 years.
§ 127 Punishment for Failure to 18% p.a. interest on delayed dividend; fines on company
Pay (₹1,000–₹10,000 per day); imprisonment up to 2 years for
officers in default; exceptions for genuine disputes and
court orders.
§ 2(35) Definition of 'Dividend' Provides the statutory definition and clarifies that dividend
includes interim dividend for purposes of the Act.
Rules, 2014 Dividend Payment Rules Companies (Declaration and Payment of Dividend) Rules,
2014 — prescribes conditions for drawing from reserves,
manner of payment, and related procedural requirements.
X. Quick-Reference Summary Table
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Topic Final Dividend Interim Dividend
Who Shareholders at AGM (by Board of Directors (Board Meeting resolution)
Declares? Ordinary Resolution)
When End of financial year at During the financial year, between two AGMs
Declared? the AGM
Board's Role Board recommends the Board declares — shareholders not involved
rate/amount
Shareholders' Can reduce rate; cannot No voting right — Board has full authority
Power increase it above Board's
recommendation
Profit Full-year audited profits Profits up to end of preceding quarter
Verification
Loss Year Cap No specific cap — Board Cannot exceed average of last 3 years' dividend rates
judgment applies
Bank Account Separate account within 5 Separate account within 5 days of Board resolution
days of AGM
Payment Within 30 days of AGM Within 30 days of Board resolution
Deadline resolution
Governing Section 123, Companies Section 123, Companies Act 2013
Section Act 2013
XI. Examiner's Notes & Common Questions
Most Frequently Tested Points: 1. Final vs. Interim dividend — who declares, when, and what
restrictions apply. 2. The 5-day and 30-day timelines — both are commonly asked in objective
questions. 3. Unpaid Dividend Account and the 7-year IEPF transfer rule. 4. Penalties under Section
127 — rates, who is liable, and the exceptions. 5. Prohibition on dividend from capital — an absolute
rule with no exceptions.
Common Exam Questions and Model Answers
Q1. What is the difference between final dividend and interim dividend?
Final dividend is recommended by the Board and declared by shareholders at the AGM at the end of the
financial year. Interim dividend is declared by the Board alone during the financial year. Shareholders vote
on final dividend (though they cannot increase the recommended rate); they have no voting role for
interim dividend. The loss-year rate cap applies only to interim dividend.
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Company Law | Declaration & Payment of Dividend | Class Notes
Q2. Can a company pay dividend out of its reserves? If so, what conditions apply?
Yes, a company may declare dividend out of its free reserves accumulated from previous years. However,
conditions under the Companies (Declaration and Payment of Dividend) Rules, 2014 apply: the rate of
dividend declared shall not exceed the average of the rates at which dividend was declared in the three
years immediately preceding that year; the total amount drawn from reserves shall not exceed one-tenth
of the paid-up share capital and free reserves as appearing in the latest audited balance sheet; and the
balance of reserves after such withdrawal shall not fall below fifteen per cent of the paid-up share capital.
Q3. What happens if a company does not pay dividend within 30 days?
If dividend is not paid within 30 days of declaration: (a) the company must transfer the unpaid amount to a
separate Unpaid Dividend Account within 7 days after the 30-day period expires; (b) the company is liable
to pay interest at 18% per annum on the unpaid amount; (c) the company is liable to a continuing fine of
₹1,000 to ₹10,000 per day; and (d) officers in default face imprisonment up to 2 years and personal fines. If
the amount remains unclaimed for 7 years, it is transferred to the IEPF.
Q4. Can shareholders increase the rate of dividend recommended by the Board?
No. This is a critical legal rule. Shareholders at the AGM can only approve the dividend at the rate
recommended by the Board, or pass a resolution reducing the rate. They have no power to increase the
dividend above the Board's recommendation. The rationale is that the Board, having examined the
company's financial position, is in the best position to determine a prudent rate of distribution.
Q5. What is the IEPF, and why is it relevant to dividend?
The Investor Education and Protection Fund (IEPF) is a fund established under Section 125 of the
Companies Act, 2013, administered by the IEPF Authority under the Ministry of Corporate Affairs. Any
dividend that remains unclaimed from the Unpaid Dividend Account for 7 consecutive years is transferred
to the IEPF. Shareholders can reclaim their dividend from the IEPF Authority by filing a prescribed
application. The fund is also used for investor education and awareness activities.
Closing Note for Students: The declaration and payment of dividend is one of the most procedurally
detailed topics in Company Law. Mastery of this topic requires remembering not just the concepts but
the specific timelines (5 days and 30 days), the authority of each organ (Board vs. shareholders), the
conditions for drawing from reserves, and the escalating consequences of default. Always read
questions carefully to identify whether they relate to final or interim dividend — the rules differ in
important ways.
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Company Law | Declaration & Payment of Dividend | Class Notes
— End of Class Notes —
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