Corporate and Economic Laws · Dividends

Section 123 Companies Act: Declaration and Payment of Dividend

Updated 11 October 2026 · Fact-checked

Section 123 of the Companies Act, 2013 lists the only sources from which a company may declare or pay dividend: current profits after depreciation, undistributed past profits, both, or government money under a guarantee. To solve questions, test the source, set off old losses, check reserve rules, then check interim dividend and payment conditions.

Understand Declaration and Payment of Dividend (Section 123)

Dividend is a company's profit shared with its shareholders. The law protects creditors by saying that capital cannot be returned as dividend. Section 123 is the main rule that controls where dividend can come from.

Under section 123(1), no dividend can be declared or paid for any financial year except out of (a) the profits of that year after providing depreciation under Schedule II, (b) undistributed profits of previous years, also after depreciation, or (c) both. A further source is money provided by the Central or a State Government to pay dividend under a guarantee it has given.

When you compute profit for this purpose, unrealised gains, notional gains, revaluation gains and fair-value changes in the carrying amount of an asset or liability are excluded. So a revaluation surplus can never fund a dividend.

The company may, before declaring dividend, transfer any percentage of that year's profit to reserves, as it considers appropriate. If profits are inadequate or absent, it may declare dividend out of accumulated profits earlier transferred to free reserves, but only in accordance with the prescribed rules. No dividend may come from reserves other than free reserves. 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.

Interim dividend is declared by the Board, not by shareholders. Section 123(3) allows it during the financial year, or after year-end until the AGM. Payment rules follow: deposit in a separate scheduled bank account within five days of declaration, and pay only to the registered shareholder (or order or banker).

Key rules to remember

Permitted sources (s.123(1)): Current year profit (after depreciation) | undistributed past profit (after depreciation) | both | government money under guarantee; Depreciation must be provided as per Schedule II. Exclude unrealised, notional and revaluation gains and fair-value changes.
Loss set-off condition: Dividend allowed only after previous losses and unprovided depreciation are set off against current profit; This is the fourth proviso to s.123(1).
Reserves rule: Transfer to reserves: any % the company considers appropriate | Dividend from reserves: free reserves only; Dividend from accumulated profits transferred to free reserves when profits are inadequate must follow the prescribed rules.
Interim dividend sources (s.123(3)): Surplus in P&L account | profits of the year for which it is declared | profits generated till the quarter preceding the date of declaration; Declared by the Board, during the year or between year-end and the AGM.
Interim dividend rate limit: If loss up to the preceding quarter end: rate ≤ average dividend rate of the immediately preceding three financial years; The cap applies only where the company has incurred a loss in the current year up to the end of the quarter immediately preceding the declaration date.
Deposit and payment: Deposit in a separate scheduled bank account within 5 days of declaration; Pay only to the registered shareholder, his order or banker; payable in cash, which includes cheque, warrant or electronic mode.
Default bar (s.123(6)): Failure to comply with sections 73 and 74 → no dividend on equity shares while the failure continues; Sections 73 and 74 deal with deposits.

How to solve Declaration and Payment of Dividend (Section 123) questions

Use this order for any question on whether a company can declare dividend, and from what.

1Identify the type: final dividend (declared at the general meeting on the Board's recommendation) or interim dividend (Board).
2Find the source. Check it is current profit after depreciation, undistributed past profit, both, or government guarantee money.
3Adjust the profit. Remove unrealised, notional, revaluation and fair-value gains. Deduct depreciation as per Schedule II.
4Set off carried-over losses and unprovided depreciation of earlier years. If they are not set off, no dividend.
5Apply the reserves rule. Decide the transfer to reserves, and if profits are short, use only free reserves and mention the prescribed rules.
6For interim dividend, check the period and source, then the three-year average rate cap if the company has a loss up to the previous quarter end.
7Check payment: separate bank account within five days, registered shareholder, and no default under sections 73 and 74.
8State your conclusion clearly with the section reference.

Quickest way: Four-gate check for dividend questions

When to use it: Use for MCQs and short case questions asking whether a dividend is valid.

Gate 1: Is the source a permitted one? Revaluation surplus and non-free reserves fail.
Gate 2: Are past losses and unprovided depreciation set off?
Gate 3: If interim, is the rate within the three-year average where a loss exists?
Gate 4: Are deposit within 5 days, registered holder and no deposit default satisfied? Any failed gate means the dividend is not allowed.

Common mistakes in Declaration and Payment of Dividend (Section 123)

Including revaluation gain in profit available for dividend.
Students see it as a credit in the accounts and treat it as profit.
Fix: Remember the proviso: unrealised, notional and revaluation gains and fair-value changes are excluded.
Forgetting depreciation before computing distributable profit.
Students start from the profit figure given in the question.
Fix: Check whether depreciation under Schedule II has been provided. Deduct it if not.
Allowing dividend from any reserve.
Students confuse reserves with free reserves.
Fix: Dividend can come only from free reserves. Capital-type reserves are not available.
Applying the three-year average cap to every interim dividend.
The rule is memorised without its condition.
Fix: The cap applies only if the company has a loss up to the end of the quarter immediately preceding the declaration date.
Ignoring old losses.
Students look only at current-year profit.
Fix: No dividend unless carried-over losses and unprovided depreciation are set off against current profit.
Saying the shareholders declare interim dividend.
Confusion with final dividend.
Fix: Interim dividend is declared by the Board of Directors.

Worked examples

Example 1

Surya Textiles Ltd has a current-year profit of ₹80,00,000 before depreciation. Schedule II depreciation of ₹30,00,000 has not yet been provided. The profit includes a ₹10,00,000 gain from revaluing land. There are no earlier losses. What profit is available for dividend?

Show the solution

Start with profit before depreciation: ₹80,00,000.
Deduct depreciation not yet provided: ₹80,00,000 − ₹30,00,000 = ₹50,00,000.
Exclude the revaluation gain, which is an unrealised gain: ₹50,00,000 − ₹10,00,000 = ₹40,00,000.
No earlier losses need set-off. The company may still transfer a percentage to reserves before declaring dividend.

Answer: Profit available for dividend is ₹40,00,000, before any transfer to reserves the company chooses to make.

Example 2

Kaveri Foods Ltd incurred a loss up to the end of the quarter preceding the date of declaration. Dividend rates in the last three years were 10%, 14% and 6%. The Board proposes an interim dividend of 12%. Is it valid?

Show the solution

The proviso to s.123(3) applies because there is a loss up to the preceding quarter end.
Average rate of the preceding three years = (10 + 14 + 6) ÷ 3 = 30 ÷ 3 = 10%.
Proposed rate 12% is higher than 10%.
So the dividend breaches the cap.

Answer: The 12% interim dividend is not valid. It can be declared at 10% at most, subject to the other conditions of section 123.

Exam tips

Quote section 123(1), 123(3) or 123(4) by number when you are sure. Examiners reward a precise reference.
In numerical cases, present a short working: profit, depreciation, exclusions, loss set-off, result.
Learn the proviso conditions word for word. MCQs often test the three-year average rule and free reserves.
Always state who declares: the Board for interim dividend.
End case answers with a clear yes or no and the reason.

Practice questions from Dividends

Declaration and Payment of Dividend (Section 123) in other exams

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

Declaration and Payment of Dividend (Section 123): frequently asked questions

Can a company pay dividend out of revaluation reserve?

No. Revaluation gains and fair-value changes are excluded when computing profit for dividend. Revaluation reserve is also not a free reserve source for dividend.

Who can declare interim dividend?

The Board of Directors. Under section 123(3) it can do so during the financial year or between year-end and the AGM.

Within how many days must the dividend amount be deposited in a bank?

Within five days from the date of declaration, in a separate account of a scheduled bank. This applies to interim dividend as well.

Can a company declare dividend if it has no profit this year?

Only out of accumulated profits earlier transferred to free reserves, and only in accordance with the prescribed rules. Past losses must also be set off first.