Company Law and Practice · Distribution of Profits

Declaration of Dividend under Section 123 of the Companies Act

Updated 11 October 2026 · Fact-checked

Section 123 of the Companies Act, 2013 lets a company declare dividend only out of current year profits after depreciation, undistributed profits of earlier years, both, or government-guarantee money. To solve a question, identify the source, check set-off of past losses and depreciation, then check reserves, interim dividend and payment rules.

Understand Declaration and Payment of Dividend

A dividend is the share of profit a company pays to its shareholders. The law protects creditors by saying where dividend can come from. A company cannot return capital to members in the name of dividend.

Under Section 123(1), dividend can be declared or paid for a financial year only out of: (a) profits of that year, arrived at after providing depreciation under Schedule II; (b) profits of earlier years, after depreciation, that remain undistributed; (c) both of these; or (d) money provided by the Central or a State Government to pay dividend under a guarantee given by that Government.

When you compute profits, you must leave out unrealised gains, notional gains, revaluation of assets and any change in the carrying amount of an asset or liability from fair value measurement. So a revaluation surplus can never fund a dividend.

The company may transfer any percentage of the year's profit it considers appropriate to reserves before declaring dividend. If profits are inadequate or absent, it may declare dividend out of accumulated profits of earlier years that were transferred to free reserves, but only as per the prescribed rules. Dividend cannot 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.

The Board may declare an interim dividend under Section 123(3). Final dividend is the one recommended by the Board and declared by the members at the general meeting. Your answer should always state the source first, then the conditions, then the conclusion.

Key rules to remember

Permitted sources of dividend (Section 123(1)): Current year profit (after depreciation) OR undistributed past profits (after depreciation) OR both OR government guarantee money; Depreciation is provided as per Schedule II. Unrealised gains, notional gains and revaluation gains are excluded from profits.
Transfer to reserves: Transfer of any percentage of profit the company considers appropriate, before declaring dividend; This is optional. The first proviso to Section 123(1) leaves the percentage to the company.
Dividend out of reserves: Only from free reserves; and only as per prescribed rules where profits are inadequate or absent; Dividend cannot be declared from reserves other than free reserves.
Set-off condition: Past losses and unprovided depreciation must be set off against current year profit before declaring dividend; This is the last proviso to Section 123(1).
Interim dividend (Section 123(3)): Board may declare out of: surplus in profit and loss account, OR profits of the year for which it is sought, OR profits generated till the quarter preceding the declaration date; Can be declared during the year or between year-end and the AGM.
Loss-making interim dividend limit: Rate ≤ average dividend rate of the immediately preceding three financial years; Applies if the company has incurred loss up to the end of the quarter preceding the declaration date.
Payment rules: Deposit in a scheduled bank in a separate account within 5 days of declaration; pay only to registered shareholder or his order or banker; Payable in cash, by cheque, warrant or electronic mode. Bonus shares capitalisation is not prohibited by this rule.
Section 73 and 74 default: No dividend on equity shares while the company fails to comply with Sections 73 and 74; The bar lasts as long as the failure continues.

How to solve Declaration and Payment of Dividend questions

Use this sequence for any question on declaring or paying dividend. It keeps your answer in the provision, facts, conclusion format.

1Read the facts and list the figures: current profit, depreciation, past losses, reserves and their type.
2Identify the source the company wants to use and test it against Section 123(1): current profit, past undistributed profit, both, or government guarantee money.
3Adjust the profit: ensure depreciation is as per Schedule II, exclude unrealised, notional and revaluation gains, and set off past losses and unprovided depreciation.
4If profits are inadequate or absent, check whether the dividend is sought from free reserves and say it must follow the prescribed rules. Reject any use of reserves that are not free reserves.
5If the question says interim dividend, confirm the Board is declaring it, name the permitted sources, and apply the three-year average cap if there is a loss up to the preceding quarter.
6Check payment points: separate bank account within five days, registered shareholder, and the Section 73 and 74 default bar.
7Write the conclusion clearly: dividend allowed or not allowed, and to what extent.

Quickest way: Source, Set-off, Reserve, Interim: the four-check scan

When to use it: Use it for short-answer or case questions when you have only a few minutes.

Source: is the money from current profit, past undistributed profit or a government guarantee?
Set-off: have past losses and unprovided depreciation been adjusted, and revaluation gains excluded?
Reserve: if it is from reserves, are they free reserves and do the prescribed rules apply?
Interim: if the Board is declaring it, check the sources and the three-year average cap in case of loss.
Close with the payment rule: separate bank account within five days.

Common mistakes in Declaration and Payment of Dividend

Treating revaluation surplus as distributable profit.
The balance sheet shows the surplus as a reserve, so it looks like profit.
Fix: Remember the proviso to Section 123(1)(a): unrealised gains, notional gains and revaluation of assets are excluded when computing profits.
Saying dividend can be paid out of any reserve.
Students remember that reserves come from profits and forget the restriction.
Fix: State that dividend cannot be paid from reserves other than free reserves, and only as per the prescribed rules when profits are inadequate or absent.
Ignoring past losses and depreciation.
Students focus on the current year's profit alone.
Fix: Apply the last proviso: no dividend unless carried over previous losses and depreciation not provided earlier are set off against current year profit.
Saying members declare interim dividend.
Students mix it up with final dividend, which is declared at the general meeting.
Fix: Section 123(3) gives the power to the Board of Directors.
Forgetting the cap on interim dividend when there is a loss.
The proviso to Section 123(3) is short and easy to skip.
Fix: If the company has incurred a loss up to the end of the quarter preceding the declaration date, the rate cannot exceed the average dividend rate of the preceding three financial years.
Stating the wrong time limit for the bank deposit.
Students confuse it with the time limits for payment or transfer to the unpaid dividend account.
Fix: Section 123(4): deposit in a scheduled bank in a separate account within five days from the date of declaration.

Worked examples

Example 1

Sunrise Textiles Ltd has a profit of ₹40,00,000 for the year after providing depreciation under Schedule II. This includes ₹10,00,000 gain from revaluation of its land. It also has carried-forward losses of ₹5,00,000 not yet set off. The Board wants to declare dividend. Advise the company on the maximum profit available for dividend.

Show the solution

Provision: Section 123(1)(a) allows dividend out of the current year's profit after depreciation, but unrealised, notional and revaluation gains are excluded in computing profits.
Exclude the revaluation gain: ₹40,00,000 − ₹10,00,000 = ₹30,00,000.
Set off past losses: the last proviso to Section 123(1) bars dividend unless carried over losses are set off against current year profit. ₹30,00,000 − ₹5,00,000 = ₹25,00,000.
The company may also transfer a percentage of profit to reserves before declaring dividend, but that is its choice and is not compulsory.

Answer: The profit available for dividend is ₹25,00,000, before any optional transfer to reserves. The revaluation gain of ₹10,00,000 cannot be distributed.

Example 2

Greenfield Foods Ltd incurred a loss up to the end of the quarter preceding the date of declaration. In the preceding three financial years it declared dividends of 6%, 9% and 12%. The Board proposes an interim dividend of 10%. Can it do so? Explain.

Show the solution

Provision: Section 123(3) allows the Board to declare interim dividend. The proviso says that where the company has incurred loss up to the end of the quarter preceding the declaration date, the interim dividend cannot be at a rate higher than the average dividends declared in the immediately preceding three financial years.
Compute the average: (6 + 9 + 12) ÷ 3 = 27 ÷ 3 = 9%.
Compare: the proposed rate of 10% is higher than 9%.
Conclusion: the proposal breaches the proviso.

Answer: The Board cannot declare a 10% interim dividend. The maximum permitted rate is 9%, the average of the preceding three years.

Exam tips

Begin every answer with Section 123(1) and list the four permitted sources. Examiners reward the correct provision first.
For case problems, show the adjustment of profit line by line. Marks are given for the working even if the final figure is slightly off.
Always mention that revaluation and other unrealised gains are excluded. This is a favourite point.
Learn the interim dividend sources and the three-year average proviso as a pair. Questions often test only the proviso.
End with a one-line conclusion naming the Act and section.

Practice questions from Distribution of Profits

Declaration and Payment of Dividend 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: frequently asked questions

Who declares dividend: the Board or the members?

Final dividend is recommended by the Board and declared by the members at the general meeting. Interim dividend is declared by the Board under Section 123(3). Always state which one the question asks about.

Can a company pay dividend when it has no profit this year?

Yes, in a limited way. It may declare dividend out of accumulated profits of earlier years that were transferred to free reserves, but only as per the prescribed rules. It cannot use reserves other than free reserves.

Must a company transfer profit to reserves before declaring dividend?

No. The first proviso to Section 123(1) says the company may transfer such percentage of profit as it considers appropriate. The transfer is optional.

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

Section 123(4) requires the dividend, including interim dividend, to be deposited in a scheduled bank in a separate account within five days from the date of declaration.

Can dividend be paid in kind or to anyone other than the registered shareholder?

Under Section 123(5), dividend is paid only to the registered shareholder, or to his order or his banker, and not otherwise than in cash. Cash payment may be made by cheque, warrant or electronic mode. Issuing fully paid-up bonus shares by capitalising profits or reserves is not barred by this rule.