Declaration and Payment of Dividend

The source of a dividend: section 123(1)

No dividend shall be declared or paid by a company for any financial year except:

• (a) out of the profits of the company for that year arrived at after providing for depreciation in accordance with section 123(2), or out of the profits of any previous financial year or years arrived at after providing for depreciation and remaining undistributed, or out of both; or
• (b) out of money provided by the Central Government or a State Government for the payment of dividend by the company in pursuance of a guarantee given by that Government.

Clause (a) gives three sources: this year's profits, undistributed past profits, or a combination. Clause (b) is the rare case of a government-guaranteed dividend.

Section 123(2) requires depreciation to be provided in accordance with Schedule II.

The four provisos, and each closes a gap

Proviso to clause (a): no paper profits. In computing profits, any amount representing unrealised gains, notional gains or revaluation of assets, and any change in the carrying amount of an asset or a liability on measurement at fair value, shall be excluded.

This is the modern accounting problem answered directly. A company whose land is revalued upwards has made no money, and cannot pay a dividend out of the increase.

First proviso: transfer to reserves is voluntary. A company may, before the declaration of any dividend, transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves.

Note "as it may consider appropriate". Under the 1956 Act a transfer was compulsory at prescribed rates. It is now the company's choice.

Second proviso: dividend out of past profits in a bad year. Where, owing to inadequacy or absence of profits in any financial year, a company proposes to declare dividend out of accumulated profits earned in previous years and transferred by the company to the free reserves, such declaration shall not be made except in accordance with such rules as may be prescribed.

Third proviso: only free reserves. No dividend shall be declared or paid by a company from its reserves other than free reserves.

Fourth proviso: clear the losses first. No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against the profit of the company for the current year.

That last proviso is frequently examined. A company with three crore rupees of profit this year and two crore of accumulated losses may pay a dividend only out of the one crore that remains after the set-off.

Interim dividend: section 123(3)

The Board of Directors may declare an interim dividend:

• during any financial year, or
• at any time during the period from closure of the financial year till holding of the annual general meeting,

out of the surplus in the profit and loss account, or out of profits of the financial year for which the interim dividend is sought to be declared, or out of profits generated in the financial year till the quarter preceding the date of declaration.

The proviso: a company making a loss. Where the company has incurred a loss during the current financial year up to the end of the quarter immediately preceding the date of declaration, the interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years.

Two things to fix. An interim dividend is declared by the Board, not by the members, whereas a final dividend is recommended by the Board and declared by the members in general meeting, being one of the four items of ordinary business under section 102(2)(a). And a loss-making company is not barred from an interim dividend; it is capped at the three year average.

Five days, and how it is paid: section 123(4) and (5)

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

Section 123(5). No dividend shall be paid except to the registered shareholder of the share, or to his order, or to his banker, and shall not be payable except in cash.

The first proviso preserves two things that look like exceptions but are not: capitalisation of profits or reserves for issuing fully paid bonus shares, and paying up any amount for the time being unpaid on shares held by members.

The second proviso explains what "in cash" means in practice: a dividend payable in cash may be paid by cheque or warrant or in any electronic mode.

Section 123(6): the deposits link. A company which fails to comply with sections 73 and 74 shall not, so long as the failure continues, declare any dividend on its equity shares.

A company that has not repaid its depositors may not pay its shareholders. The same instinct appears in section 70(1)(c) for buy-back.

The Unpaid Dividend Account: section 124

Section 124(1). Where a dividend has been declared but has not been paid or claimed within thirty days from the date of the declaration, the company shall, within seven days from the expiry of those thirty days, transfer the total unpaid or unclaimed amount to a special account in any scheduled bank called the Unpaid Dividend Account.

So the timeline is thirty days, then seven. Thirty-seven days after declaration the money must be out of the company's own accounts.

Section 124(2): publish the names. Within ninety days of making the transfer, the company shall prepare a statement containing the names, last known addresses and the unpaid dividend payable to each person, and place it on the company's website, if any, and on any other website approved by the Central Government, in the prescribed form and manner.

The purpose is obvious: a shareholder who has moved house can find his own name.

Section 124(3): interest for not transferring. On default in transferring the amount, the company shall pay interest at twelve per cent per annum from the date of the default, and the interest accruing shall enure to the benefit of the members in proportion to the amount remaining unpaid to them.

Section 124(4). Any person claiming to be entitled to money in the Account may apply to the company for payment.

Section 124(5): the seven year rule. Money in the Unpaid Dividend Account which remains unpaid or unclaimed for seven years from the date of transfer shall be transferred by the company, with any interest accrued, to the Fund established under section 125(1), and the company shall send a statement in the prescribed form of the details to the authority administering the Fund, which shall issue a receipt.

Section 126: the register is not disturbed while a transfer is pending. Where a transfer of shares has been lodged and not registered, the company must transfer the dividend to the Unpaid Dividend Account unless the registered holder has authorised in writing that it be paid to the transferee, and must keep in abeyance any offer of rights shares and any issue of fully paid bonus shares in relation to those shares.

The Investor Education and Protection Fund: section 125

Section 125(1). The Central Government shall establish a Fund to be called the Investor Education and Protection Fund.

Section 125(2): what is credited to it. Among other things:

• (a) amounts given by the Central Government by way of grants, after due appropriation by Parliament;
• (b) donations by the Central or State Governments, companies or other institutions;
• (c) the amount in the Unpaid Dividend Account transferred under section 124(5);
• (d) amounts transferred from the general revenue account under the corresponding provision of the Companies Act 1956;

together with matured deposits and debentures, application money and interest, which remain unclaimed for the periods the section prescribes, and the disgorged amounts and proceeds referred to in section 38(4) and elsewhere.

Section 125(3) provides what the Fund is used for, which includes the refund of unclaimed dividends, matured deposits and debentures, application monies and interest to claimants, the promotion of investors' education, awareness and protection, and the reimbursement of legal expenses in class actions under section 245.

Section 125(5) provides for the authority that administers the Fund, and it is that authority to which the shares of a significant beneficial owner are transferred under the proviso to section 90(9), and to which disgorged gains go under section 38(4).

Punishment for failure to distribute: section 127

Where a dividend has been declared but has not been paid, or the warrant has not been posted, within thirty days from the date of declaration to any shareholder entitled to it:

• every director of the company, if he is knowingly a party to the default, shall be punishable with imprisonment up to two years and with a fine of not less than one thousand rupees for every day during which the default continues; and
• the company shall be liable to pay simple interest at eighteen per cent per annum during the period of the default.

Note three features. The liability of a director requires that he was knowingly a party to the default. The fine is per day, not a lump sum. And this is one of the provisions where imprisonment survived the decriminalisation of the Act, because withholding declared dividend is treated as taking the shareholders' own money.

The proviso: five situations where no offence is committed.

• (a) where the dividend could not be paid by reason of the operation of any law;
• (b) where a shareholder has given directions regarding payment which cannot be complied with, and that has been communicated to him;
• (c) where there is a dispute regarding the right to receive the dividend;
• (d) where the dividend has been lawfully adjusted by the company against any sum due to it from the shareholder; or
• (e) where, for any other reason, the failure was not due to any default on the part of the company.

Clause (e) is a general saving, and clause (d) is the one students forget: a company may set a declared dividend against calls the member owes.

A worked example

Jalna Steels Limited has, for the year ended 31 March 2028, a profit after depreciation under Schedule II of five crore rupees, accumulated losses of one crore fifty lakh rupees, a revaluation surplus on its land of two crore rupees, and free reserves of three crore rupees.

What it may pay out of. The revaluation surplus is excluded by the proviso to section 123(1)(a), being a revaluation of assets. By the fourth proviso the carried-over loss of one crore fifty lakh must first be set off, leaving three crore fifty lakh rupees of distributable profit for the year. It may add undistributed profits of earlier years, and, if it draws on reserves, only on free reserves by the third proviso.

Transfer to reserves. It may, before declaring, transfer such percentage of the year's profits as it considers appropriate to reserves: first proviso. It is not obliged to transfer anything.

Declaration. The final dividend is recommended by the Board and declared by the members at the annual general meeting on 14 September 2028, that being ordinary business under section 102(2)(a).

Five days. The whole amount must be deposited in a separate account in a scheduled bank within five days of declaration, by 19 September 2028: section 123(4).

Payment. It is paid only to the registered shareholder, or to his order or his banker, and in cash, which by the second proviso to section 123(5) means it may be paid by cheque, warrant or electronic mode.

A deposit default. Suppose the company were in default under sections 73 and 74. By section 123(6) it could not declare any dividend on its equity shares so long as the failure continued.

An interim dividend. In December 2028 the Board wishes to declare an interim dividend. It may, out of the surplus in the profit and loss account or out of profits of the year to the quarter preceding the declaration. But the company has made a loss in the current year up to the end of September. By the proviso to section 123(3) the interim dividend may not exceed the average of the dividends declared in the immediately preceding three financial years.

Unclaimed dividend. Of the September dividend, four lakh rupees is unclaimed thirty days after declaration, by 14 October 2028. Within seven days of that, by 21 October 2028, it must go into the Unpaid Dividend Account in a scheduled bank: section 124(1). If the company fails to transfer it, it pays twelve per cent per annum interest from the date of default, and that interest enures to the members in proportion to what they are owed: section 124(3).

Publication. Within ninety days of the transfer the company must publish a statement of names, last known addresses and amounts on its own website and on the Central Government's approved website: section 124(2).

Seven years. Any of that four lakh still unclaimed on 21 October 2035, seven years after the transfer, goes with accrued interest to the Investor Education and Protection Fund under section 125, and the company sends a statement of details to the authority, which issues a receipt: section 124(5).

A shareholder is not paid. Mr Kale's dividend is neither paid nor its warrant posted within thirty days. The company owes simple interest at eighteen per cent per annum for the period of default, and every director knowingly a party to it faces imprisonment up to two years and a fine of not less than one thousand rupees for every day: section 127.

Unless. If Mr Kale had asked for payment into an account that no longer existed and the company had told him so, clause (b) applies; if his entitlement is disputed, clause (c); if the company lawfully set the dividend against unpaid calls, clause (d); and if the failure was for any other reason not due to the company's default, clause (e). In none of those is an offence committed.

Distinctions that carry marks

What this does NOT mean

It does not mean a company must transfer profits to reserves before a dividend. The first proviso to section 123(1) makes it as the company considers appropriate.

It does not mean a revaluation surplus can be distributed. Unrealised gains, notional gains, revaluation and fair value changes are excluded in computing profits.

It does not mean a loss-making company can never pay an interim dividend. It may, but not at a rate higher than the average of the preceding three financial years.

It does not mean unclaimed dividend is forfeited to the company. It goes to the Unpaid Dividend Account, and after seven years to the Investor Education and Protection Fund, from which a claimant may still seek a refund under section 125(3).

Quick revision

• 123(1): dividend only out of this year's profits after Schedule II depreciation, undistributed past profits, or both, or out of Government money for a guaranteed dividend. Provisos: exclude unrealised gains, notional gains, revaluation and fair value changes; transfer to reserves is voluntary; dividend out of accumulated profits in a bad year only per the rules; only free reserves; and set off carried-over losses and unprovided depreciation first.
• 123(3): interim dividend by the Board, during the year or between the year end and the AGM, out of the surplus in the profit and loss account or profits to the preceding quarter. Loss in the year to that quarter caps it at the three year average.
• 123(4): deposit in a separate account in a scheduled bank within five days. 123(5): pay only to the registered shareholder, his order or his banker, and in cash, which includes cheque, warrant or electronic mode; bonus shares and paying up unpaid amounts are unaffected. 123(6): no equity dividend while in default under sections 73 and 74.
• 124(1): unpaid or unclaimed after thirty days, transfer within seven days to the Unpaid Dividend Account. (2) publish names, last known addresses and amounts within ninety days on the company's and the Government-approved website. (3) failure to transfer, twelve per cent interest, enuring to the members. (4) a claimant may apply to the company. (5) unclaimed for seven years, to the Fund with interest.
• 125: the Investor Education and Protection Fund, credited with grants, donations, section 124(5) transfers and other unclaimed amounts, used for refunds to claimants, investor education and protection, and reimbursing class action costs.
• 126: where a transfer of shares is lodged but not registered, the dividend goes to the Unpaid Dividend Account unless the registered holder authorises otherwise, and rights and bonus entitlements are kept in abeyance.
• 127: not paid or the warrant not posted within thirty days: every director knowingly a party faces imprisonment up to two years and not less than one thousand rupees for every day, and the company pays eighteen per cent simple interest. Five exceptions, including a lawful adjustment against sums due from the shareholder.

Test yourself

1. Out of what may a dividend be declared? Out of the profits of the company for that year after providing for depreciation under Schedule II, or out of the undistributed profits of any previous financial year or years similarly arrived at, or out of both; or out of money provided by the Central or a State Government for a dividend under a guarantee given by that Government: section 123(1).

2. What must be excluded in computing profits for this purpose? Any amount representing unrealised gains, notional gains or revaluation of assets, and any change in the carrying amount of an asset or liability on measurement at fair value: proviso to section 123(1)(a).

3. Must a company set off past losses before declaring a dividend? Yes. The fourth proviso to section 123(1) provides that no company shall declare dividend unless carried over previous losses and depreciation not provided in previous years are set off against the profit of the current year.

4. Who declares an interim dividend, and what limit applies if the company is in loss? The Board of Directors, under section 123(3). Where the company has incurred a loss in the current financial year up to the end of the quarter immediately preceding the declaration, the interim dividend shall not be declared at a rate higher than the average dividends declared during the immediately preceding three financial years.

5. Trace an unclaimed dividend through the Act. It must be paid within thirty days of declaration; within seven days of the expiry of those thirty it goes to the Unpaid Dividend Account in a scheduled bank; within ninety days of that transfer the names, last known addresses and amounts are published on the company's website and a Government-approved website; and after seven years from the transfer it goes, with accrued interest, to the Investor Education and Protection Fund.

6. State the consequences of failing to pay a declared dividend within thirty days. The company is liable to pay simple interest at eighteen per cent per annum for the period of the default, and every director knowingly a party to it is punishable with imprisonment up to two years and a fine of not less than one thousand rupees for every day the default continues: section 127. No offence is committed in the five situations listed in the proviso.