Declaring a Dividend in a Private Limited Company: Section 123, the Free-Reserve Rule, Interim vs Final, TDS After DDT, and the Unpaid-Dividend Trap (India 2026)

The company made money. Now you want to take some home — legally.

Your private limited company has a healthy profit and cash in the bank, and you want to pay yourself and your co-shareholders out of it. The instinct is to just transfer the money. Do that and you have created an unreported director's loan, a tax problem, or worse. The clean, legal route for owners to take profit out of a company is a dividend — and dividends run on their own rulebook: where the money can come from, how much you can pay, the board and shareholder approvals, the TDS you must deduct, and a set of deadlines that turn expensive if you miss them. This is the guide to declaring and paying a dividend in a private limited company the right way — the Companies Act mechanics under Section 123, the taxation after Dividend Distribution Tax was scrapped, and the traps around unpaid dividends and the IEPF.

What a dividend actually is — and where it can come from

A dividend is a distribution of a company's profits to its shareholders, in proportion to the shares they hold. It is not a salary, not a director's fee, and not a loan — it is the return on ownership. Because it moves company money into private hands, the law is strict about the source. Section 123 of the Companies Act, 2013 allows a dividend to be declared and paid only out of:

• the profits of the company for the current financial year, arrived at after providing for depreciation in line with Schedule II; or
• the undistributed profits of previous financial years, again after depreciation; or
• money provided by the Central or State Government for the payment of a dividend under a guarantee it has given.

Two hard limits sit on top of this. A dividend can be paid out of free reserves only — never out of a reserve that is not free, such as a revaluation reserve or the securities premium. And the profit figure has to exclude unrealised, notional and fair-valuation gains: you cannot pay a dividend out of a paper gain from revaluing an asset. Real, realised profit, after depreciation, is the well you draw from.

Paying a dividend in a lean year: the Rule 3 brake

What if the current year was thin or loss-making, but the company has fat accumulated profits from earlier years? You can still pay a dividend out of those accumulated profits, but Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014 puts three brakes on it, so a company cannot strip its reserves bare in a bad year:

• the rate of dividend cannot exceed the average of the rates at which dividend was declared in the three immediately preceding years;
• the total amount drawn from accumulated profits cannot exceed one-tenth (1/10th) of the sum of paid-up share capital and free reserves as per the latest audited financial statements;
• the amount drawn is first used to set off the current year's losses, and after the withdrawal the balance of reserves must not fall below fifteen per cent (15%) of paid-up share capital.

These caps only apply when you dip into past reserves because the current year is inadequate. In a normal profitable year you declare a dividend out of that year's profit and Rule 3 does not bite.

Interim versus final: who declares, and when

There are two kinds of dividend, and they follow different approval paths.

• A final dividend is recommended by the Board and then declared by the shareholders at the Annual General Meeting. The members can approve the Board's recommended rate or reduce it, but they cannot increase it. Once declared, it becomes a debt the company owes.
• An interim dividend is declared by the Board of Directors alone, during a financial year or between the year-end and the AGM, out of the surplus in the profit and loss account and the profits of the year in which it is declared. No shareholder meeting is needed.

Section 123(3) adds a sensible guard on interim dividends: if the company has made a loss in the current financial year up to the end of the quarter immediately before the declaration, the interim dividend rate cannot be higher than the average of the dividends declared in the three preceding financial years. In other words, you cannot pay a generous interim dividend while the year so far is in the red.

The mechanics: resolution, the five-day account, thirty-day payment

Declaring a dividend is a sequence of steps, each with its own timing:

• Board resolution. The Board meets to recommend a final dividend (for the AGM) or to declare an interim dividend. This is minuted like any board decision.
• Shareholder approval for a final dividend. The members declare it by ordinary resolution at the AGM.
• Separate bank account within five days. The total dividend amount must be deposited into a separate bank account within five days of the declaration. The money is ring-fenced from the company's working funds from that moment.
• Payment within thirty days. The dividend must reach shareholders — by bank transfer, or by a warrant or cheque — within thirty days of the date of declaration.

One more gate: a company that is in default of repaying deposits it accepted under Sections 73 and 74 cannot declare a dividend until that default is made good. Profit sitting in the company does not entitle you to a dividend if depositors are still owed.

The tax picture: DDT is gone, the shareholder pays now

The single biggest change in how dividends are taxed happened in 2020, and it reversed decades of practice. Until then, the company paid Dividend Distribution Tax (DDT) and the dividend was tax-free in the shareholder's hands. The Finance Act, 2020 abolished DDT with effect from 1 April 2020. Since then, dividends are taxable in the hands of the shareholder at their applicable slab rate — the "classical" system of dividend taxation.

That shift created a compliance duty for the company paying the dividend: TDS under Section 194 of the Income-tax Act, 1961. The rules a private company must apply:

• Deduct TDS at 10% on the dividend paid to a resident shareholder, if the aggregate dividend to that shareholder in the financial year exceeds ₹10,000. This threshold was raised from ₹5,000 to ₹10,000 by the Budget 2025, effective 1 April 2025 (FY 2025-26).
• Both interim and final dividends count towards that ₹10,000 threshold.
• If the shareholder does not furnish a PAN, Section 206AA forces TDS at the higher rate of 20%.
• The TDS applies to all domestic companies alike — listed, unlisted, public and private. A small private company paying a dividend to its own promoters is squarely within Section 194.

So the money a shareholder actually receives is the dividend net of 10% TDS, and the shareholder then reports the gross dividend as income and claims credit for the tax deducted. Getting the TDS wrong — not deducting, or deducting under the wrong PAN — is one of the most common dividend errors we clean up.

Unpaid dividends: the seven-year road to the IEPF

What happens to a dividend that is declared but not collected — a shareholder who has moved, a bounced warrant, a wrong bank detail? Section 124 sets out a strict escalator, and it ends with the money leaving the company for good:

• Any dividend not paid or claimed within thirty days of declaration must be moved to a special account called the Unpaid Dividend Account, opened in a scheduled bank, within seven days of the thirty-day period ending.
• If the company fails to make that transfer, it owes interest at 12% per annum on the amount, and the interest benefits the members in proportion.
• The company must place a statement of unclaimed amounts on its website so shareholders can find and claim what is theirs.
• Any amount that stays unclaimed for seven years from the date it went into the Unpaid Dividend Account is transferred to the Investor Education and Protection Fund (IEPF) established under Section 125 — and, critically, the shares on which the dividend has been unclaimed for seven consecutive years are transferred to the IEPF as well.

That last point surprises people: neglect an unclaimed dividend long enough and the shareholder loses not just the cash but the shares themselves, which then have to be reclaimed from the IEPF through a separate process. For a small private company this rarely bites, but the machinery is real and the seven-year clock is unforgiving.

Miss the deadline, and it gets expensive: Section 127

Section 127 puts teeth into the thirty-day payment rule. Where a dividend is declared but not paid — or the warrant not posted — within thirty days, and the default is not covered by one of the narrow exceptions, the consequences are steep:

• Every director who is knowingly a party to the default can face imprisonment up to two years and a fine of not less than ₹1,000 for every day the default continues; and
• the company is liable to pay simple interest at 18% per annum for the period of the default.

The exceptions are limited — a court order restraining payment, a lawful adjustment of money the shareholder owes the company, a genuine dispute over the right to receive the dividend, directions from the shareholder that could not be carried out, or a cause genuinely beyond the company's control. "We were busy" is not on the list. Once you declare, the clock is running and the interest is punitive.

Where this fits in running your company

A dividend is the payout end of a well-run company, and it connects to almost everything else in the compliance calendar. The final dividend is approved at the same meeting where the accounts are adopted, so it sits inside the machinery of board meetings, the AGM and the minutes and registers that record it. The declaration and the TDS feed into the year's AOC-4 and MGT-7 annual filings. If your reason for a dividend is really to move money to a director, compare it honestly against the tighter rules on a loan to a director under Section 185 — a dividend is usually the cleaner route. Dividends are paid per share, so the register of members and any recent share transfers decide who gets paid, and a company planning larger payouts may first need to restructure its capital. All of it sits under our pillar on the annual ROC compliance calendar for a private limited company.

How we handle it at RDA, Baner

At RDA Advisory in Baner, Pune, we treat a dividend as a tax decision as much as a company-law one. Before you declare anything, we check the source — that there is genuine, realised profit or free reserve to pay from, and that Rule 3 is satisfied if you are dipping into past years. We draft the board and AGM resolutions, set up the separate bank account within the five-day window, compute and deduct the right TDS under Section 194 (and flag any shareholder without a PAN before the 20% rate hits), file the TDS return, and make sure every rupee is paid inside the thirty-day deadline so Section 127 never applies. We also weigh a dividend against salary and director's loans, because the most tax-efficient way to take money out of your company is rarely just one of them. If you are sitting on profit and want to take some out cleanly, talk to us first. You will find us at Office No. 102, Snehraj Apartment, Baner, Pune 411045, on +91 77570 45059.

Book a consult at rdatax.in

Want to pay yourself a dividend without tripping the source rules, the TDS or the thirty-day clock? We will confirm what you can pay, draft the resolutions, handle the TDS and the filings, and plan the payout so it is the most efficient way to move profit into your hands. Book a consultation at rdatax.in or call the Baner office, and take your profit out the right way.

Verification note: this guide reflects the dividend provisions of the Companies Act, 2013 — Section 123 (declaration out of profits and free reserves, Schedule II depreciation, the separate-account and interim-dividend rules), Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014, Section 124 (Unpaid Dividend Account and the seven-year transfer of unclaimed dividends and shares to the IEPF under Section 125), and Section 127 (the 18% interest and director penalties for failure to distribute) — together with the abolition of Dividend Distribution Tax by the Finance Act, 2020 and the TDS on dividends under Section 194 of the Income-tax Act, 1961, including the ₹10,000 deduction threshold effective 1 April 2025 and the 20% no-PAN rate under Section 206AA, as understood at the time of writing. Rates, thresholds, timelines and monetary penalties are periodically revised, so confirm the current position on the MCA and Income-tax portals or with your CA before declaring a dividend.