Legal Provisions for Declaration and Payment of Dividend

3. Legal Provisions for Declaration and Payment of Dividend — Companies Act, 2013

Section 123 — Sources of dividend. No dividend may be declared or paid by a company for any financial year except:

1. out of the profits of that financial year, arrived at after providing for depreciation in accordance with Schedule III / the Act; or
2. out of the profits of any previous financial year(s), similarly arrived at after providing for depreciation, and remaining undistributed; or
3. out of both (1) and (2) together; or
4. out of money provided by the Central Government or a State Government for payment of dividend in pursuance of a guarantee given by that government.

Depreciation is compulsory before any dividend. A company must provide for depreciation before it can treat any surplus as available for dividend — this prevents a company from distributing what is really a return of its own capital (through unprovided wear-and-tear of assets) disguised as profit.

Voluntary transfer to reserves. Before declaring a dividend, a company may, at its own discretion, transfer such percentage of its profits to reserves as it considers appropriate. (Under the earlier Companies Act, 1956, a minimum transfer to reserves was compulsory beyond a certain dividend rate; the 2013 Act makes this entirely voluntary.)

Dividend out of free reserves, in the absence of adequate profits. Where a company proposes to declare dividend out of free reserves in a year in which it has inadequate or no profits, the Companies (Declaration and Payment of Dividend) Rules, 2014 require it to observe conditions such as: the rate of dividend so declared cannot exceed the average of the rates at which dividend was declared in the preceding three years; the total amount drawn from accumulated reserves cannot exceed one-tenth of the paid-up share capital and free reserves; the amount so drawn must first be used to set off any losses incurred in the financial year before any dividend is paid; and the balance of reserves after such a withdrawal cannot fall below fifteen per cent of the paid-up share capital.

Set-off of past losses and unprovided depreciation. A company cannot declare dividend while ignoring losses of previous years and depreciation not provided for in previous years — these must first be set off against the current year's profit.

Separate bank account — Section 123(4). Within five days of the declaration of any dividend, the company must deposit the entire amount of dividend payable into a scheduled bank account, kept separate from the company's other accounts.

Section 124 — Unpaid Dividend Account. Where a dividend has been declared but has not been paid, or a dividend warrant has not been posted, to a shareholder within 30 days of declaration, the company must, within seven days of the expiry of that 30-day period, transfer the unpaid/unclaimed amount to a special account called the Unpaid Dividend Account, opened in any scheduled bank. Within 90 days of making this transfer, the company must prepare a statement of all sums so transferred, including the last known addresses of the shareholders entitled, and place it on the company's own website (and any other website the Central Government may specify). Any interest earned on the money in the Unpaid Dividend Account belongs to the shareholders who are entitled to the underlying dividend, in proportion to their claim.

Section 125 — Investor Education and Protection Fund (IEPF). If any amount remains unpaid/unclaimed in the Unpaid Dividend Account for seven consecutive years from the date it was transferred there, the company must transfer that amount, along with the interest accrued, to the Investor Education and Protection Fund established by the Central Government under Section 125. Along with the unclaimed dividend, the shares on which such dividend has remained unclaimed for seven consecutive years must also be transferred to the IEPF's demat account (Section 124(6)). The IEPF is also credited with other unclaimed corporate amounts (matured deposits, matured debentures, application money due for refund, and the interest on all of these), and is used to promote investor awareness and protection, and to refund amounts to investors who later come forward and prove their claim through the IEPF Authority. …