Dividend Distribution by a Closely Held Private Limited Company — A Complete Guide by a Company Secretary

Corporate Law Advisor – StartBizzIndia

Introduction

One of the most common questions that arise in closely held private limited companies is — ‘How can we distribute profits to shareholders legally and efficiently?’ While business owners often treat it as a simple payout, dividend distribution is a regulated corporate action governed by the Companies Act, 2013, the Income Tax Act, 1961, and related accounting standards.

This article explains how a private limited company can declare and distribute dividends, from which amount, what procedure to follow, its impact on financial statements, and the tax implications for both the company and shareholders.

1. What is a Dividend?

Dividend is the share of profit distributed by a company among its shareholders in proportion to their shareholding. It represents the reward to owners for their investment and confidence in the company’s business.

Under Section 2(35) of the Companies Act, 2013, “dividend” includes interim dividend. Thus, there are two types:

1. Final Dividend – Declared after the close of the financial year by shareholders in AGM based on the recommendation of the Board.
2. Interim Dividend – Declared during the financial year by the Board of Directors.

2. Source of Dividend – Section 123 of the Companies Act, 2013

A company can declare dividend only out of:

• Past undistributed profits, transferred to Free Reserves;
• Combination of the above; or
• Free reserves, when there is inadequacy or absence of profit (as per Rule 3 of the Companies (Declaration and Payment of Dividend) Rules, 2014).
• Not permitted: Dividend cannot be declared from capital profits, revaluation reserves, or unrealized gains.

3. Preconditions for Declaration

Before recommending or declaring any dividend, ensure the following:

• All depreciation as per Schedule II is provided.
• No default in repayment of deposits, debentures, or interest thereon.
• Transfer to reserves is optional post-2016 amendment.
• Adequate liquidity exists to meet the payout within 30 days.
• Compliance with TDS provisions under the Income Tax Act.

4. Step-by-Step Process of Dividend Declaration

A. Final Dividend:

Step	Particulars	Responsible Authority
Step	Particulars	Board of Directors
1	Hold a Board Meeting to recommend dividend amount based on audited accounts	Members
2	Convene AGM and get shareholders’ approval through Ordinary Resolution	Company
3	Open a separate dividend bank account within 5 days of declaration	Company
4	Pay dividend within 30 days of declaration	Company
5	Transfer any unpaid amount to Unpaid Dividend Account within 7 days after expiry of 30 days	Company
6	File annual forms AOC-4 and MGT-7 mentioning the dividend details	Company

B. Interim Dividend:

Step	Particulars	Responsible Authority
1	Board Meeting to declare interim dividend	Board
2	Transfer to separate bank account within 5 days	Company
3	Pay within 30 days	Company
4	Record and disclose in financial statements	Company

5. Impact on Financial Statements

When a dividend is declared, it affects both the Statement of Changes in Equity and Cash Flow Statement.

Transaction	Debit	Credit
On declaration	Surplus in P&L (Retained Earnings)	Dividend Payable (Liability)
On payment	Dividend Payable	Bank

• Dividend reduces Reserves & Surplus (Net Worth).
• Reflected as “Appropriation of Profit” in financial statements.
• Appears under Financing Activities in the Cash Flow Statement.

6. ROC Compliances and Forms

Compliance	Form	Timeline	Legal Reference
Board Resolution (if required under AoA)	MGT-14	Within 30 days	Sec. 117
Annual Return	MGT-7	Within 60 days of AGM	Sec. 92
Financial Statements	AOC-4	Within 30 days of AGM	Sec. 137
Transfer to IEPF	IEPF-1	Within the prescribed period	Sec. 124

7. Tax Implications (Post DDT Era)

A. For the Company:

After abolition of Dividend Distribution Tax (DDT) from 1st April 2020, dividends are no longer taxable in the hands of the company. However, TDS under Section 194 of the Income Tax Act applies

Particular	TDS Rate	Threshold
Resident Shareholders	10%	If dividend > ₹5,000 per shareholder per FY
Non-Resident Shareholders	20% or lower rate as per DTAA	Nil threshold

• If PAN not furnished → TDS @ 20%.

• Company must deposit TDS within 7 days of month end and file Form 26Q quarterly.

B. For the Shareholders

• Dividend income is now taxable in the hands of shareholders under “Income from Other Sources” (Sec. 56).

• Applicable tax rate → as per individual slab.

Only one deduction is allowed:

• Interest expense incurred for earning such dividend (up to 20% of dividend income) under Section 57.

8. Illustrative Example

XYZ Tech Private Limited (FY 2024-25):

Particulars	Amount (₹)
Net Profit (after tax)	50,00,000
Free Reserves (Opening)	40,00,000
Paid-up Share Capital	1,00,00,000
Proposed Dividend	20% = ₹20,00,000
TDS @10%	₹2,00,000
Net Payout	₹18,00,000

Journal Entries:

1. Dr. Surplus in P&L ₹20,00,000

Cr. Dividend Payable ₹20,00,000

• Dr. Dividend Payable ₹20,00,000

Cr. Bank ₹18,00,000

Cr. TDS Payable ₹2,00,000

Financial Impact:

• Retained earnings reduced by ₹20 lakh
• Cash outflow ₹18 lakh
• TDS liability ₹2 lakh

9. Practical Tips & Best Practices

• Ensure Articles of Association permit dividend declaration.
• Avoid recommending a dividend if there is any pending statutory or financial default.
• Keep Board and AGM minutes well-drafted and documented.
• Maintain Dividend Register and proof of payment.
• Track Unpaid Dividend Account for timely IEPF transfer.
  File TDS returns and issue Form 16A promptly.

10. Conclusion

Dividend declaration is more than a goodwill gesture. It is a regulated financial event that reflects the company’s governance and compliance maturity. For closely held private limited companies, following the correct process ensures profits are distributed lawfully, financial statements remain accurate, and directors avoid penalties. StartBizzIndia assists companies in structuring dividend policies, ensuring legal compliance, and managing end-to-end documentation and filings.