Companies Act Section 123

Companies Act, Section 123: Declaration of Dividend

Section 123 of the Companies Act outlines the legal framework governing the declaration and payment of dividends by companies. It establishes conditions under which dividends can be declared, ensuring financial prudence and compliance with accounting standards. 

This section aims to protect shareholders' interests while maintaining corporate financial stability.

A dividend is a return given to shareholders from a company's profits, and this section prescribes the sources from which dividends can be paid, conditions for declaration, rules for interim dividends, and restrictions on dividend payments.

1. Sources of Dividend Payment

Under subsection (1), a company cannot declare or pay dividends for any financial year unless it satisfies specific conditions regarding the source of funds from which the dividend is paid.

(a) Dividend Must Be Paid from Profits

A company can declare and distribute dividends only from:

1. Profits of the Current Financial Year:

The company must determine its profits after accounting for depreciation as per subsection (2) and the prescribed accounting standards.

2. Undistributed Profits from Previous Financial Years:

The company may also declare dividends from profits earned in previous years, provided those profits have been retained as reserves and accounted for after depreciation.

3. Exclusion of Unrealised Gains and Asset Revaluation:

Any amount representing unrealised gains, notional gains, or revaluation of assets should be excluded from the computation of profits.

This ensures that dividends are distributed only from actual earnings and not from paper gains or fluctuating asset values.

(b) Dividend Paid from Government-Provided Funds

A company may also pay dividends from funds provided by the Central Government or a State Government, specifically if the government has guaranteed such payments.

2. Conditions and Restrictions on Dividend Declaration

To ensure financial discipline and fairness, the law places additional restrictions and requirements before dividends can be declared.

(a) Transfer of Profits to Reserves

Before declaring dividends, a company may transfer a percentage of its profits to its reserves as it deems appropriate.

This provision helps companies strengthen financial stability by ensuring that some earnings are retained instead of being entirely distributed.

(b) Payment of Dividends from Accumulated Profits

If a company has inadequate or no profits in a particular financial year, it may declare dividends from accumulated profits transferred to free reserves.

However, this is subject to rules prescribed by regulatory authorities, ensuring that companies do not misuse accumulated reserves to declare unsustainable dividends.

(c) Restriction on Declaring Dividend from Non-Free Reserves

Companies are strictly prohibited from declaring dividends from any reserves other than free reserves.

This ensures that dividends are not paid using funds earmarked for specific obligations or liabilities.

(d) Set-Off of Previous Losses and Depreciation

A company cannot declare dividends unless it has fully accounted for any past losses and depreciation from previous years.

This provision ensures that dividends are paid only when the company is in a sound financial position, preventing unsustainable payouts.

3. Depreciation Requirements

Under subsection (2), the law mandates that depreciation must be provided for before declaring dividends.

The company must calculate depreciation as per Schedule II of the Companies Act to ensure uniformity in financial reporting.

This provision ensures that a company maintains an accurate financial position before distributing earnings to shareholders.

4. Interim Dividend

Under subsection (3), the Board of Directors has the authority to declare an interim dividend under the following conditions:

(a) When Can Interim Dividend Be Declared?

During any financial year or after the financial year ends but before the annual general meeting (AGM).

It can be declared out of the surplus in the profit and loss account, the profits of the financial year, or profits generated till the quarter preceding the declaration.

(b) Restriction in Case of Losses

If a company has incurred a loss up to the end of the quarter immediately preceding the interim dividend declaration, it cannot declare an interim dividend at a rate higher than the average dividend rate of the past three financial years.

This restriction prevents companies with declining profits from declaring unsustainable dividends.

5. Deposit of Dividend Funds in a Bank

Under subsection (4), the law mandates that once a company declares a dividend:

The total amount, including any interim dividend, must be deposited into a scheduled bank in a separate account within five days from the date of declaration.

This ensures that dividends are properly accounted for and available for distribution, preventing mismanagement or misuse of funds.

6. Payment of Dividends

Under subsection (5), the law prescribes rules regarding how dividends should be paid:

(a) Payment to Registered Shareholders Only

Dividends can only be paid to:

1. The registered shareholder of the shares.

2. A person authorized by the shareholder.

3. The shareholder’s banker.

This ensures that dividends are rightfully distributed to the intended recipients.

(b) Mode of Payment

Cash payments are prohibited except in specific circumstances.

However, dividends can be paid through:

1. Cheque or warrant (physical payment methods).

2. Electronic transfer to the shareholder’s bank account.

This provision modernizes dividend payments and ensures secure, traceable transactions.

(c) Issuance of Bonus Shares in Lieu of Dividend

The law allows companies to capitalize their profits or reserves for:

Issuing fully paid-up bonus shares instead of cash dividends.

Paying off unpaid amounts on existing shares held by shareholders.

This provision provides companies with flexibility in rewarding shareholders while retaining cash reserves for operational needs.

7. Restrictions on Dividend Declaration in Case of Non-Compliance

Under subsection (6), a company that fails to comply with sections 73 and 74 (relating to the acceptance and repayment of deposits) is prohibited from declaring dividends on equity shares until it rectifies the default.

This provision ensures that companies prioritize legal and financial obligations before making dividend payments.

Shareholders are protected from receiving dividends that may be based on non-compliant or unstable financial practices.

8. Key Takeaways and Significance of Section 123

(a) Ensuring Financial Prudence

The requirement to declare dividends only from profits or free reserves prevents companies from distributing dividends irresponsibly.

Setting aside depreciation and previous losses ensures long-term financial stability.

(b) Protection of Shareholders' Interests

By restricting dividend payments to registered shareholders, the law prevents unauthorized claims and ensures transparency.

The deposit of dividend amounts in a separate bank account ensures timely distribution.

(c) Flexibility in Dividend Declaration

Companies can declare interim dividends during the financial year to reward shareholders periodically.

The option to issue bonus shares instead of cash dividends provides flexibility in capital management.

(d) Preventing Misuse of Funds

By prohibiting dividend declarations for companies in default of deposit repayment, Section 123 prevents financial mismanagement.

Excluding unrealized gains and revaluation profits from dividend calculations ensures that dividends are based on actual earnings.