Corporate and Other Laws · Declaration and Payment of Dividend

Sources of Dividend and Conditions for Declaration under Section 123

Updated 4 October 2026 · Fact-checked

Under Section 123, a company may declare dividend only out of current year profits after depreciation, undistributed profits of earlier years after depreciation, both, or money provided by Government under a guarantee. Solve questions by identifying the source, checking depreciation, loss set-off and reserve conditions, then concluding.

Understand Sources of Dividend and Conditions for Declaration

A dividend is the company's profit shared with shareholders. The law protects creditors by saying that dividend must come from real, distributable profit and not from capital. Section 123(1) lists the only permitted sources.

There are two broad sources. The first is profits: profits of the current year, or undistributed profits of previous years, or both. In every case profit must be arrived at after providing for depreciation as per Schedule II. The second is Government money: money provided by the Central or a State Government to pay dividend under a guarantee given by that Government.

Profit has a special filter. When you compute profit for dividend, you must exclude unrealised gains, notional gains, revaluation of assets and any change in the carrying amount of an asset or liability on fair value measurement. So a paper gain on revaluation cannot be distributed.

The company may, before declaring dividend, transfer any percentage of that year's profit to reserves, as it considers appropriate. The law sets no minimum percentage in the Act itself. Separately, dividend cannot be declared from reserves other than free reserves.

If there is no profit or too little profit in a year, the company may want to pay from accumulated profits earlier transferred to free reserves. This is allowed only as per the prescribed rules. Also, no dividend can be declared unless carried over previous losses and depreciation not provided in earlier years are set off against the current year's profit. So a company cannot pay dividend out of accumulated losses.

Key rules to remember

Permitted sources (Section 123(1)): Dividend only out of: (a) current year profit after depreciation, or (b) undistributed profit of previous years after depreciation, or (c) both, or (d) Government money under a guarantee; Depreciation must be provided as per Schedule II, as Section 123(2) states.
Exclusion from profit: Exclude unrealised gains, notional gains, revaluation of assets and fair value changes in carrying amount of assets or liabilities; This is the proviso to Section 123(1)(a). Such items cannot support dividend.
Transfer to reserves: Transfer of such percentage of current profit to reserves as the company considers appropriate, before declaring dividend; This is optional and no percentage is fixed in the section.
Reserves other than free reserves: No dividend out of reserves other than free reserves; Section 123 itself only bars dividend from reserves other than free reserves. The definition of free reserves is in Section 2(43). The point that reserves created by revaluation of assets are not free reserves comes from that definition, not from Section 123. Always check the type of reserve against the definition.
Loss and depreciation set-off: No dividend unless carried over previous losses and depreciation not provided in earlier years are set off against current year profit; This is why accumulated losses block dividend. In a numerical, 'carried over losses' means only losses not already absorbed or set off elsewhere. Set off only that amount against current profit.
Dividend from accumulated profits when profits are inadequate: Allowed out of accumulated profits transferred to free reserves, only as per prescribed rules; Section 123 says the declaration must be made in accordance with the prescribed rules (Companies (Declaration and Payment of Dividend) Rules, 2014). Do not state their limits unless you know them.
Default in deposits: No dividend on equity shares while the company fails to comply with Sections 73 and 74 (deposits); Section 123(6). It applies only for so long as the failure continues.

How to solve Sources of Dividend and Conditions for Declaration questions

Use this order for any scenario question on sources of dividend. It follows the section and earns step marks for provision, facts and conclusion.

1Name the provision: Section 123 of the Companies Act, 2013 deals with the declaration of dividend.
2Identify the proposed source: current profit, past undistributed profit, reserves, Government money, or something else such as capital, revaluation surplus or securities premium.
3Check that depreciation is provided as per Schedule II. If not, recompute profit after depreciation first.
4Remove unrealised, notional and revaluation gains and fair value changes from profit.
5Set off carried over previous losses and unprovided depreciation of earlier years against current profit, as the law requires. Use only losses not already absorbed elsewhere.
6If reserves are used, check that they are free reserves (defined in Section 2(43)) and that profits are inadequate or absent. If so, state that the prescribed rules (Companies (Declaration and Payment of Dividend) Rules, 2014) must be followed.
7Check Section 123(6): has the company defaulted under Sections 73 and 74? If yes, no dividend on equity shares during the default.
8Conclude clearly: dividend permitted, or not permitted, and the source from which it can be paid.

Quickest way: Source, filter, conclude

When to use it: Use in MCQs and short scenario questions where time is tight.

For an MCQ, ask first: is the source profit after depreciation, free reserves under the rules, or Government guarantee money? Anything else (capital, revaluation reserve, unrealised gain) is wrong.
Eliminate options that allow dividend despite accumulated losses not set off.
For a written answer use three lines: Provision (Section 123), Facts (apply the numbers), Conclusion (allowed or not).
Always show profit computed after depreciation as a separate line so you earn step marks even if the final call differs.

Common mistakes in Sources of Dividend and Conditions for Declaration

Treating revaluation surplus as distributable profit.
Students see it as a gain in the balance sheet and assume it is profit.
Fix: Remember the proviso: revaluation of assets and notional or unrealised gains are excluded when computing profit for dividend.
Ignoring depreciation when computing profit for dividend.
Questions often give profit before depreciation to test attention.
Fix: Always deduct depreciation as per Schedule II first. Dividend profit must be after depreciation.
Saying a company can pay dividend out of any reserve.
The word reserve is confused with free reserve.
Fix: Write: no dividend out of reserves other than free reserves. Check the type of reserve in the question.
Forgetting to set off previous losses.
Students look only at current year profit.
Fix: Check the proviso that carried over previous losses and unprovided depreciation must be set off against current profit before declaring dividend.
Quoting a fixed percentage as the compulsory transfer to reserves.
Older rules and memory of earlier law create confusion.
Fix: Under the text of Section 123(1) the company may transfer such percentage as it considers appropriate. Do not state a compulsory percentage.
Missing the Sections 73 and 74 restriction.
It sits in sub-section (6), away from the sources.
Fix: Add a line: a company in default under Sections 73 and 74 cannot declare dividend on equity shares while the default continues.

Worked examples

Example 1

X Ltd has profit for the year of ₹40,00,000 before depreciation. Depreciation as per Schedule II is ₹10,00,000. Carried over losses from earlier years not yet set off are ₹12,00,000. The profit includes ₹3,00,000 of unrealised gain on fair valuation of an asset. Assume the carried-over losses have not already been absorbed or set off elsewhere. Can X Ltd declare dividend for this year, and what is the maximum current-year profit available for it?

Show the solution

Provision: Section 123 allows dividend out of current year profit arrived at after providing for depreciation.
Profit after depreciation = ₹40,00,000 − ₹10,00,000 = ₹30,00,000.
Exclude unrealised gain: ₹30,00,000 − ₹3,00,000 = ₹27,00,000.
Assumption: the ₹12,00,000 of carried-over losses has not already been absorbed or set off elsewhere, so the full amount is set off against current profit.
Set off carried over previous losses against this profit: ₹27,00,000 − ₹12,00,000 = ₹15,00,000.
The company may, before declaring dividend, transfer some percentage of profit to reserves as it considers appropriate. This is optional, so ₹15,00,000 is the maximum available before any such transfer.
Any other lawfully available undistributed profits of earlier years are not considered here, as the question gives none.

Answer: Yes. After excluding the unrealised gain and setting off the earlier losses (on the stated assumption), the maximum current-year profit available is ₹15,00,000, before any transfer to reserves. X Ltd can declare dividend out of this profit, less any amount it chooses to transfer to reserves.

Example 2

Y Ltd incurred a loss this year. It has ₹20,00,000 in general reserve created out of past profits, and ₹15,00,000 in revaluation reserve. The Board wants to declare dividend from both reserves. Advise the Board.

Show the solution

Provision: Section 123 allows dividend only from profits, accumulated profits transferred to free reserves under prescribed rules, or Government guarantee money. It also bars dividend from reserves other than free reserves.
Free reserves are defined in Section 2(43). Under that definition, a reserve created by revaluation of assets is not a free reserve. This point rests on the definition, not on Section 123. So the ₹15,00,000 revaluation reserve cannot be used.
General reserve created out of past profits is a free reserve. Where profits are inadequate or absent, dividend may be declared out of accumulated profits earlier transferred to free reserves, but only as per the prescribed rules (Companies (Declaration and Payment of Dividend) Rules, 2014).
Also check that previous losses and unprovided depreciation are set off, and that the company has not defaulted under Sections 73 and 74.

Answer: The Board cannot use the revaluation reserve of ₹15,00,000. It may use the general reserve of ₹20,00,000 only as per the prescribed rules (Companies (Declaration and Payment of Dividend) Rules, 2014), after the loss and depreciation conditions are met and if there is no default under Sections 73 and 74.

Exam tips

In MCQs, options mentioning revaluation reserve, unrealised gains or capital as a source are almost always wrong.
In scenario questions, compute profit after depreciation as a visible first step. Then deduct earlier losses.
Use the three-part format: provision, facts, conclusion. Mention Section 123 by number.
Do not quote exact limits under the dividend rules unless you are certain. Say that the prescribed rules apply.
Read for traps such as a default on deposits, which stops equity dividend under Section 123(6).

Practice questions from Declaration and Payment of Dividend

Sources of Dividend and Conditions for Declaration in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Sources of Dividend and Conditions for Declaration: frequently asked questions

Out of which sources can dividend be declared under Section 123?

Dividend can be declared out of current year profits after depreciation, undistributed profits of previous years after depreciation, or both. It can also be paid out of money provided by the Central or State Government under a guarantee. Accumulated profits transferred to free reserves can be used only as per the prescribed rules.

Can a company declare dividend out of accumulated losses?

No. The law says no company shall declare dividend unless carried over previous losses and depreciation not provided in earlier years are set off against the current year's profit. Dividend needs distributable profit, not capital.

Is transfer to reserves compulsory before declaring dividend?

Under the text of Section 123(1), a company may transfer such percentage of its profits to reserves as it considers appropriate. The section does not fix a compulsory percentage. The transfer is therefore a matter for the company's judgement.

Can dividend be paid out of revaluation reserve?

No. Profit for dividend excludes revaluation of assets and unrealised or notional gains. Dividend is also barred out of reserves other than free reserves. Free reserves are defined in Section 2(43), and under that definition reserves created by revaluation of assets are not free reserves. That last point comes from the definition, not from Section 123.