Corporate Accounting and Financial Management · Dividend Decisions

Legal and Regulatory Aspects of Dividend under Companies Act 2013

Updated 11 October 2026

Under Section 123(1) of the Companies Act, 2013, dividend can be declared only out of current-year profit after depreciation, undistributed profits of earlier years after depreciation, or Government money. Free reserves can be used only in limited cases under the Rules. Pay within 30 days; unpaid amounts go to the Unpaid Dividend Account and later the IEPF.

Understand Legal and Regulatory Aspects of Dividend

Dividend is the part of profit a company shares with its shareholders. The law controls it for one reason: money paid out as dividend cannot be used to pay creditors. So the Companies Act, 2013 sets rules on where dividend may come from, how it is declared and how fast it is paid.

The main rules are in Section 123. Under Section 123(1), dividend can be declared only out of: (a) profits of the current financial year, arrived at after providing for depreciation; (b) profits of any previous year(s), after depreciation, that remain undistributed; or (c) money provided by the Central or a State Government for payment of dividend, as a guarantee. The company may also transfer part of its profit to reserves before declaring dividend. Such a transfer is voluntary under the current Act.

Free reserves are not a source under Section 123(1). They can be used only in the limited case allowed by Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014, where the company has inadequate or no profit in a year. In that case the rate cannot be more than the average of the rates of dividend in the three years just before, the amount drawn from reserves must first be used to set off the losses of that year, and the balance of free reserves after the withdrawal must be at least 15% of the paid-up share capital. Revaluation reserve is not free reserve and cannot be used for dividend or for issuing bonus shares.

Payment rules matter as much as declaration rules. A dividend payable in cash is paid by cheque, warrant or any electronic mode to the registered shareholder (or to his order or his banker). It must be paid within 30 days of declaration. The company must deposit the total amount of the declared dividend, including interim dividend, in a separate account with a scheduled bank within 5 days of the date of declaration (Section 123(4)). If the dividend remains unpaid or unclaimed after 30 days, the amount is transferred to a special account called the Unpaid Dividend Account (Section 124) within 7 days of the end of the 30-day period.

Money left in that account for 7 years from the date of transfer must be transferred to the Investor Education and Protection Fund (IEPF). The Fund is established under Section 125, and the duty to transfer arises under Section 124. Shares on which dividend has not been paid or claimed for 7 consecutive years are also transferred to the IEPF. The shareholder can still claim the money and shares from the IEPF Authority by following the prescribed procedure. SEBI adds a layer for listed companies: under the LODR Regulations, the top 1000 listed companies by market capitalisation must frame and disclose a dividend distribution policy.

Key rules to remember

Sources of dividend (Section 123): Current year profit (after depreciation) | Undistributed past profits (after depreciation) | Government money for dividend; These are the sources in Section 123(1). Free reserves are not a source here; they can be used only in the limited cases under Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014.
Payment time limit: Pay within 30 days of declaration; Default makes the company and officers liable to penalty and the company must pay interest as the Act prescribes.
Separate dividend account and Unpaid Dividend Account: Deposit the total declared dividend in a separate scheduled bank account within 5 days of declaration (Section 123(4)); transfer the amount unpaid or unclaimed after 30 days to the Unpaid Dividend Account within 7 days of the end of the 30-day period (Section 124); These are two steps. The 5-day deposit is under Section 123(4). The transfer to the Unpaid Dividend Account is under Section 124.
IEPF transfer: Unpaid for 7 years in the Unpaid Dividend Account → transfer to IEPF (Section 124; Fund established under Section 125); Shares are also transferred where dividend is unclaimed for 7 consecutive years.
Dividend out of free reserves: rate cap: Rate ≤ average of the dividend rates of the 3 years immediately preceding; Applies where the company has inadequate or no profit in the year.
Dividend out of free reserves: reserves floor: Free reserves left after withdrawal ≥ 15% of paid-up share capital; This replaces any vague idea of a net worth floor. The test is on free reserves, not on all reserves. Check it on the latest audited figures.
Interim dividend: Declared by the Board during the year; paid out of surplus in P&L account or profits of the period; If the company has incurred a loss in the current year up to the end of the quarter preceding the declaration, the interim dividend rate cannot be higher than the average dividend rate of the last three financial years.
SEBI LODR: Top 1000 listed companies by market capitalisation must have a dividend distribution policy; The policy must be disclosed on the website and in the annual report.

How to solve Legal and Regulatory Aspects of Dividend questions

Use this order for any question on legal aspects of dividend. It keeps your answer in ICSI style: provision, facts, conclusion.

1Identify what is asked: source of dividend, a condition, a time limit, or unpaid dividend handling.
2State the provision in plain words and cite Section 123 (or the relevant rule or SEBI regulation) where you are sure.
3Check the source: current profit after depreciation, past undistributed profit or Government money. Test free reserves only if profit is inadequate, under Rule 3 of the Dividend Rules.
4If free reserves are used, apply the conditions one by one: rate cap, set-off of the year's losses first, and the 15% floor on remaining reserves.
5Apply the time limits from the facts: 30 days for payment, 5 days for the separate account, 7 days for transfer, 7 years for IEPF.
6Work out any figure asked (dividend amount, reserve transfer, rate cap) with clear steps.
7Write a one-line conclusion that answers the exact question.

Quickest way: Source-Condition-Time check

When to use it: Use it for short-answer and case-based questions where you have a few minutes.

Write the source of dividend in one line.
Write the single condition that the facts test.
Write the time limit that applies.
Conclude: allowed or not allowed, and what the company must do next.

Common mistakes in Legal and Regulatory Aspects of Dividend

Allowing dividend without charging depreciation first
Students treat profit as the figure before depreciation.
Fix: Always say profit is computed after providing for depreciation, then apply the source rule.
Treating transfer to reserves as compulsory
Old rules fixed a percentage and students still remember them.
Fix: Say the Companies Act, 2013 lets the company decide the amount it transfers to reserves, voluntarily.
Mixing up the 30-day and 7-year periods
Both numbers appear in the unpaid dividend rules.
Fix: 30 days is for payment; unpaid amount goes to the Unpaid Dividend Account; 7 years in that account leads to the IEPF.
Using the average of the last three years incorrectly
Students average the wrong years or include the current year.
Fix: Take the three financial years immediately before the current year and use their declared rates.
Forgetting that IEPF money can still be claimed
The word transfer suggests the shareholder loses the right.
Fix: State that the shareholder may claim the amount or shares from the IEPF Authority by the prescribed procedure.
Ignoring SEBI for listed companies
Students answer only from the Companies Act.
Fix: For listed companies add the LODR dividend distribution policy for the top 1000 companies by market capitalisation.

Worked examples

Example 1

A company declared a final dividend on 10 March. Some shareholders did not claim it. State the steps the company must follow regarding the account and unpaid amounts, with the dates, using 10 March as the declaration date.

Show the solution

Provision: dividend must be paid within 30 days of declaration.
Separate account: under Section 123(4), the company must deposit the total dividend amount in a separate account with a scheduled bank within 5 days of declaration. 10 March + 5 days = 15 March.
Payment period: 30 days from 10 March. March has 31 days, so 21 days take us to 31 March and the remaining 9 days to 9 April. The period ends on 9 April.
Transfer: under Section 124, any dividend still unpaid or unclaimed after the 30 days must be transferred to the Unpaid Dividend Account within 7 days of the end of the 30-day period. 9 April + 7 days = 16 April.
Later stage: if the amount remains in the Unpaid Dividend Account for 7 years, it must be transferred to the IEPF (Section 124, with the Fund established under Section 125).

Answer: Deposit the dividend in a separate scheduled bank account by 15 March (Section 123(4)), pay by 9 April, transfer unpaid amounts to the Unpaid Dividend Account by 16 April (Section 124), and move them to the IEPF after 7 years. The shareholder can still claim from the IEPF.

Example 2

A company has no profit in the current year. Its dividend rates in the last three years were 10%, 12% and 8%. Paid-up capital is ₹50,00,000. What is the maximum dividend it can declare out of free reserves, subject to the rate cap, and which other conditions apply?

Show the solution

Average rate of the three preceding years = (10 + 12 + 8) ÷ 3 = 30 ÷ 3 = 10%.
Maximum rate allowed = 10%.
Maximum dividend = 10% of ₹50,00,000 = ₹5,00,000.
Free reserves floor: the balance of free reserves after the withdrawal must be at least 15% of paid-up capital = 15% of ₹50,00,000 = ₹7,50,000.
Other conditions: the amount drawn from reserves must first be used to set off the losses of the year, and revaluation reserve cannot be used because it is not free reserve.

Answer: The company can declare at most 10%, which is ₹5,00,000, from free reserves, provided free reserves of at least ₹7,50,000 remain after the withdrawal and the other conditions are met.

Exam tips

Cite Section 123 at the start of a theory answer, then list the sources of dividend as short points.
Learn the numbers in a chain: 5 days, 30 days, 7 days, 7 years. Questions often test one of them.
For numerical questions, compute the three-year average rate first and show it clearly.
For listed companies, add one line on the SEBI LODR dividend distribution policy for the top 1000 companies.
End each answer with a clear conclusion, such as allowed or not allowed, to earn the final mark.

Practice questions from Dividend Decisions

Legal and Regulatory Aspects of Dividend: frequently asked questions

What does Section 123 of the Companies Act, 2013 deal with?

It deals with declaration and payment of dividend. It sets the sources from which dividend may be paid, the rules for interim dividend and the conditions when free reserves are used.

What happens to unpaid dividend?

It must be moved to the Unpaid Dividend Account after the 30-day payment period. If it stays unclaimed for 7 years, it goes to the IEPF. The shareholder can still claim it from the IEPF Authority.

Is a transfer to reserves compulsory before declaring dividend?

No. Under the Companies Act, 2013 the company may transfer any percentage of profit to reserves, as it decides. The earlier fixed percentages no longer apply.

Which companies need a dividend distribution policy under SEBI rules?

The top 1000 listed companies by market capitalisation must frame the policy under the LODR Regulations. They must also disclose it on their website and in the annual report.