Declaring dividend is often seen as a sign of a company’s profitability and goodwill toward its shareholders. However, companies in India cannot freely declare dividends whenever they want. The Companies Act, 2013 and other regulatory frameworks lay down clear restrictions on when and how dividends can be declared.

These legal boundaries ensure that dividend payments are made ethically, responsibly, and without harming the financial health of the company or the interests of its stakeholders.

Let’s explore when a company is not allowed to declare dividends, along with relevant legal provisions and frequently asked questions in a human, easy-to-follow format.

What is a Dividend

A dividend is a portion of a company’s profits that is distributed to its shareholders. It can be in the form of:

• Final dividend – declared at the end of the financial year in an Annual General Meeting (AGM)

• Interim dividend – declared by the Board of Directors between two AGMs

While distributing profits sounds simple, several legal conditions must be met before dividends can be declared.

When a Company Cannot Declare Dividends: Key Restrictions

- No Profits or Inadequate Profits

As per Section 123(1) of the Companies Act, 2013, a company can only declare dividends out of:

• Current year’s profits after providing for depreciation

• Past accumulated profits transferred to free reserves

If the company has no profits or inadequate profits, it cannot declare dividends unless it follows special rules for using reserves (explained below).

Failure to Provide for Depreciation

A company must provide for depreciation on all assets, in accordance with Schedule II of the Companies Act, 2013, before declaring any dividend. Ignoring depreciation will lead to a direct violation of Section 123.

Dividend Declared from Capital (Not Allowed)

Dividends can only be declared out of profits—not out of capital. Doing so is illegal and considered mismanagement or fraud, which may attract penalties under Section 447 (fraud) of the Companies Act.

Non-Compliance with Section 73 & 74 (Public Deposits)

If a company has defaulted in repayment of deposits or interest thereon, it cannot declare dividends. This is as per Section 123(6) of the Companies Act, 2013.

The idea is to ensure that a company first clears its obligations to depositors before rewarding shareholders.

Default in Redemption of Debentures or Preference Shares

As per Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014, if a company has failed to redeem debentures or preference shares, it cannot declare dividends until the default is cleared.

Default in Repayment of Term Loans or Interest to Banks

Although not specifically under the Companies Act, lenders like banks or financial institutions often place restrictions in loan agreements, prohibiting companies from declaring dividends until their loans or EMIs are paid on time.

Violation of such covenants can lead to loan recall or legal action.

Non-Compliance with Income Tax Provisions

If a company has defaulted in payment of TDS (Tax Deducted at Source) on dividends declared earlier, it may face restrictions or penalties from the Income Tax Department. Moreover, declaring dividends without accounting for dividend distribution tax (if applicable) in earlier years may trigger scrutiny.

Pending Legal Orders or Tribunal Proceedings

If the company is under investigation, insolvency, or subject to NCLT or SEBI orders, dividend declaration might be put on hold. In case of listed companies, SEBI (LODR) Regulations require full disclosure and compliance before dividends can be issued.

Summary of Key Provisions

Frequently Asked Questions (FAQs)

- Can a company declare dividends even if it has losses in the current year?

Yes, but only if it has adequate free reserves and follows the Companies (Declaration and Payment of Dividend) Rules, 2014.

- Can dividend be declared if the company has not filed income tax returns?

There is no direct restriction under the Companies Act, but it may raise compliance red flags. Also, TDS on dividends must be paid, or it may lead to tax penalties.

- Can a startup company declare dividends in its early years?

Only if it has net profits after depreciation and meets all compliance requirements. Most startups reinvest earnings for growth rather than paying dividends.

- What happens if dividends are declared illegally or wrongly?

Directors can be held personally liable. Under Section 447, such misdeclaration is considered fraud, and heavy penalties or imprisonment may apply.

- Can an LLP declare dividends like companies?

No. LLPs don’t declare dividends. Instead, profits are shared as per the LLP Agreement.

Conclusion

Dividends may seem like a generous gesture to shareholders, but they come with a set of strict legal conditions. The Companies Act, 2013 ensures that only financially healthy and compliant companies distribute dividends. This protects creditors, depositors, and other stakeholders from unfair practices.