Company Law and Practice · Distribution of Profits

Dividend: Meaning, Types and Legal Framework under Companies Act, 2013

Updated 11 October 2026 · Fact-checked

A **dividend** is the part of a company's profits that it distributes to its members. Under the Companies Act, 2013, section 123 allows it only out of permitted sources, such as current or past profits after depreciation. Types include interim, final, preference and equity dividend. Answer by stating the type, the source, the conditions and a conclusion.

Understand Dividend: Meaning, Types and Legal Framework

A dividend is a share of the company's profits paid to its shareholders in proportion to their shares. The company is a separate legal person, so profits belong to it first. Members get them only when the company validly declares a dividend. A member has no right to a dividend until it is declared.

The Companies Act, 2013 does not define dividend in section 123. It controls when and from what source a dividend can be declared. The aim is to protect creditors by keeping the company's capital intact. This is why dividends are tied to profits and not to capital.

By timing, there are two main types. A final dividend is recommended by the Board and declared by the members at the annual general meeting. An interim dividend is declared by the Board during the financial year, or between the close of the year and the AGM. Under section 123(3) it may come out of the surplus in the profit and loss account, the profits of that year, or profits generated up to the quarter before the declaration date.

By class of share, there is preference dividend and equity dividend. Preference shareholders get dividend at the fixed rate in their terms of issue, ahead of equity shareholders. Equity shareholders get what is left, at a rate that varies. Preference shareholders usually vote only on limited matters, but under section 47(2) if their dividend is unpaid for two years or more, that class can vote on all resolutions.

Section 123 also fixes the mechanics. The dividend amount must be deposited in a separate account in a scheduled bank within five days of declaration. It is paid only to the registered shareholder, or to his order or banker. It is payable in cash, which may be by cheque, warrant or electronic mode. Capitalisation of profits to issue fully paid bonus shares is not treated as a dividend payment.

Key rules to remember

Sources of dividend (section 123(1)): Dividend only out of: (a) current year profits after depreciation; (b) undistributed profits of previous years after depreciation; (c) both; or (d) money provided by Government under a guarantee; Depreciation is provided as per Schedule II. Unrealised, notional and fair-value gains are excluded when computing profits.
Transfer to reserves: Company may transfer any percentage of profits it considers appropriate to reserves before declaring dividend; This is optional under the first proviso. It is not a fixed percentage.
Dividend out of accumulated profits: If profits are inadequate or absent, dividend out of accumulated profits transferred to free reserves only as per prescribed rules; No dividend may be paid from reserves other than free reserves.
Set-off of losses: No dividend unless carried-over previous losses and depreciation not provided in earlier years are set off against current year profit; Often missed in answers.
Interim dividend (section 123(3)): Declared by the Board out of surplus in P&L account, profits of the year, or profits up to the quarter before declaration; If there is a loss up to the preceding quarter, the rate cannot exceed the average dividend of the preceding three financial years.
Deposit and payment: Deposit in a separate scheduled bank account within 5 days of declaration; pay only to registered holder, in cash (cheque, warrant or electronic mode); Applies to interim dividend also.
Bar on default: A company failing to comply with sections 73 and 74 cannot declare dividend on equity shares while the failure continues; Sections 73 and 74 deal with deposits.
Preference shareholder voting: Dividend unpaid for 2 years or more on a class: that class can vote on all resolutions (section 47(2) second proviso); Otherwise voting is limited to matters affecting their rights, winding up, and repayment or reduction of share capital.

How to solve Dividend: Meaning, Types and Legal Framework questions

Use this method for any question on dividend, whether it is theory or a short problem.

1Identify the type of dividend asked: interim, final, preference or equity, and who declares it.
2State the rule in section 123 in plain words, naming the section.
3Check the source: current profits after depreciation, past undistributed profits, both, or Government money. Exclude unrealised and fair-value gains.
4Check the conditions: earlier losses and unprovided depreciation set off, only free reserves used, and no default under sections 73 and 74.
5For interim dividend, apply section 123(3) and the three-year average limit if there is a loss up to the preceding quarter.
6Check the mechanics: separate bank account within five days, payment to the registered holder, payment by cash, cheque, warrant or electronic mode.
7Apply the rule to the facts given in the question.
8Write a clear conclusion: whether the dividend is permitted or not, and why.

Quickest way: Source, condition, payment check

When to use it: Use when you have little time and the question gives facts asking whether a company can declare a dividend.

Ask: is there a lawful source (profits after depreciation, or Government guarantee money)?
Ask: have old losses and unprovided depreciation been set off?
Ask: is any part coming from non-free reserves? If yes, it is not allowed.
Ask: is the company in default under sections 73 and 74? If yes, no equity dividend.
For interim dividend, check the loss and three-year average limit.
Conclude in one line, citing section 123.

Common mistakes in Dividend: Meaning, Types and Legal Framework

Saying dividend can be paid out of capital if the company wishes.
Students think the company is free to use any money it holds.
Fix: Dividend can come only from the sources listed in section 123(1). Capital is not one of them.
Ignoring depreciation when computing distributable profit.
Students treat accounting profit as distributable profit.
Fix: Profits must be arrived at after providing depreciation under Schedule II. Write this every time.
Saying the Board declares final dividend.
Interim and final dividend are mixed up.
Fix: The Board recommends the final dividend and members declare it at the AGM. The Board itself declares interim dividend.
Forgetting the limit on interim dividend when there is a loss.
The proviso to section 123(3) is overlooked.
Fix: If there is a loss up to the quarter before declaration, the rate cannot exceed the average of the previous three years.
Writing that dividend may be paid in kind or to any holder.
The payment rules in section 123(5) are not revised.
Fix: Dividend is payable in cash, by cheque, warrant or electronic mode, to the registered shareholder or his order or banker. Bonus shares by capitalisation are a separate matter.
Missing that unpaid preference dividend gives voting rights.
Students link voting rights only with equity shares.
Fix: Under section 47(2), a class whose dividend is unpaid for two years or more can vote on all resolutions.

Worked examples

Example 1

Nilgiri Tea Ltd. has no profit in the current year. It has accumulated profits of earlier years, partly held in a revaluation reserve arising from revaluing its land. The Board wants to pay dividend out of the whole reserve. Advise.

Show the solution

Provision: section 123(1) permits dividend only out of the listed sources, and no dividend may be paid from reserves other than free reserves.
Where profits are inadequate or absent, dividend out of accumulated profits transferred to free reserves is allowed only as per prescribed rules.
Revaluation of assets is an unrealised gain. The proviso to section 123(1)(a) says such gains are excluded in computing profits.
A revaluation reserve is not a free reserve of realised profits, so it cannot be used.

Answer: Nilgiri Tea Ltd. cannot pay dividend out of the revaluation reserve. It may use only accumulated profits transferred to free reserves, and only in accordance with the prescribed rules.

Example 2

Kaveri Foods Ltd. had a loss up to the end of the quarter preceding the date of declaration. Its dividends in the last three years were 10%, 14% and 12%. The Board proposes an interim dividend of 15%. Is it valid?

Show the solution

Provision: section 123(3) lets the Board declare interim dividend.
The proviso says that if there is a loss up to the preceding quarter, the rate cannot be higher than the average dividend of the previous three financial years.
Average = (10 + 14 + 12) ÷ 3 = 36 ÷ 3 = 12%.
Proposed rate 15% is higher than 12%.

Answer: The 15% interim dividend is not valid. The Board may declare at most 12%.

Exam tips

Begin every answer with the definition and cite section 123, then move to facts.
Learn the difference between interim and final dividend as a table-style list in your mind: who declares, when, and source. Write it as points.
In problem questions, check the loss set-off and free reserves conditions before concluding.
Remember the five-day deposit rule and payment mode. Examiners like precise details.
Use the exact words of the Act, such as 'free reserves' and 'registered shareholder'.

Practice questions from Distribution of Profits

Dividend: Meaning, Types and Legal Framework in other exams

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

Dividend: Meaning, Types and Legal Framework: frequently asked questions

What is dividend under the Companies Act, 2013?

It is the share of profits a company distributes to its members. Section 123 governs the source, declaration and payment. It does not give a separate definition, so write the meaning in your own words and cite section 123.

What is the difference between interim and final dividend?

The Board declares interim dividend during the year or before the AGM. Final dividend is recommended by the Board and declared by members at the AGM. Interim dividend is limited by the sources in section 123(3).

Can a company pay dividend if it has a loss?

Not from current profits. It may use accumulated profits transferred to free reserves, only as per the prescribed rules. Earlier losses and unprovided depreciation must be set off first.

Within what time must declared dividend be deposited?

The amount must be deposited in a separate account in a scheduled bank within five days from the date of declaration. This applies to interim dividend too.