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Dividends and Managerial Remuneration

Learning Objectives

After completing this module, you should be able to answer the following questions:

  1. When is dividend declared?
  2. How is dividend computed?
  3. How much of its profits can a company distribute to shareholders?
  4. Can a company declare dividends if it has made losses?
  5. Can a company declare dividends at any time it wants to (i.e. before the close of the financial year)?
  6. Can shareholders modify the rate of dividend proposed by directors?
  7. What is the maximum limit on remuneration of directors of a public company or a private company?
  8. Is a director’s salary dependent on the profits of the company?


Who is this for? How is it relevant for your career?
It is natural for a company and its promoters to be interested in retaining top talent – hence, remuneration of promoters, directors and its key employees becomes a crucial concern for any business. Remuneration of owners and employees is regulated by both law and contract. Lawyers, Company Secretaries and Accountants play an important role in advising companies in creating compensation and incentivisation mechanisms for their owners and employees. In this chapter, we discuss the restraints and regulatory limits that are prescribed under the Companies Act. Contractual and other mechanisms (that is, employment agreements and stock options) will be discussed in a subsequent chapter.

How do different stakeholders derive value from the company?

Different shareholder groups in the company look at deriving value from their investment in different ways – investors largely look towards an appreciation in the value of the company. In listed companies, capitalizing profits (by announcing bonus issues) is a great way to reward individual and institutional shareholders. This leads to shareholders owning more shares of the company without contributing additional capital. What do founders and entrepreneurs look at? Multiple avenues of deriving value and remuneration are available to founders. The startup they have promoted is also often their only investment – they committed their capital and time to it, and it is also their source of employment. 

Understanding the ways in which entrepreneurs can earn remuneration from their company

In a startup, an entrepreneur can remunerate himself in multiple ways. He can derive value from the growth of the company (as the value of his equity will correspondingly appreciate). While this is the most valuable source of growth for an entrepreneur, this value cannot be unlocked by the entrepreneur until he sells a portion of his shares, which is not possible in a short duration of time. Therefore, earning dividends on shares, or drawing a salary from the company are other mechanisms for an entrepreneur to remunerate himself till he is invested in the company or is involved in conducting its business.


During early stages, an entrepreneur may choose to draw a salary (usually in capacity as a director) from a company as a salary is more tax efficient compared to dividends. Using dividend as a way to reward oneself is not tax efficient for an early stage startup, because the company is taxed twice in the process, once when it earned the profit (at 30%) and the second time on the amount distributed as dividend (at 16% on the distributed amount). On the other hand, amount paid out as salary can be deducted as an expense from the revenues of the company. The director will have to pay income tax at the personal income tax slab (and not at a flat rate), which results in a much lower rate of taxation.


As a company grows, an entrepreneur’s ability to utilize the above mechanisms to remunerate himself for his efforts reduces – once it is funded by angel or VC investors, the ability of founders to earn money through their shareholding or through salaries is governed more tightly by contractual mechanisms. For example, the ability of founders to sell a portion of their stake may be subject to the investors’ consent. The investors may also insist that they should be able to find an exit from the company before the founders sell their stake.


Similarly, declaration of dividends and salaries of directors are usually subject to the consent of investors. Such consent requirements are usually specified in a shareholder’s agreement executed with the investors, or in an employment agreement with the directors (both of which are usually executed at the time of funding). The Companies Act prescribes the governing framework, but does not directly impose ceilings on remuneration of directors of private companies. However, once a company goes public, remuneration of its directors is heavily regulated by the act.


In this chapter, we discuss how declaration of dividends and remuneration of directors is regulated by the Companies Act in detail.A quick reference chart explaining the ways in which remuneration can be claimed is provided below:


Part 1 – Dividends

Dividend is the return on the investments of shareholders in companies to reward them for investing in the company. Dividend is usually declared at the end of the financial year, when the balance sheet and the profit and loss accounts are presented to the shareholders in the annual general meeting (AGM).


Dividend is declared out of profits (they could be current or past years’ accumulated profits) of the company.Higher rates of dividends can incentivize shareholders to stay invested in the company. However, shareholders do not necessarily invest in anticipation of high dividends. The primary intention behind investing is appreciation in the value of the shares – as the company grows, the value of its shares will also increase.


Entrepreneurs should note that declaring dividends from its profits may sometimes not be in the interest of the company (for example if a company is in its early stages), as it may be preferable to re-invest all profits for the growth of the business. Venture capitalists (VCs) and private equity investors (PE investors) are usually sensitive to this and do not insist on receiving dividends on their investment (the key reward they are looking at is an exit by selling the shares of the company at a much higher valuation, say 10 times or more than the value of the company when they invested). In fact, VCs and PE investors insist that before declaring a dividend, consent must be taken from their representatives on the company.


However, unsophisticated investors or those who do not invest professionally may not appreciate the commercial interests of the company in the same manner. Where a company has such investors, it is important that promoters retain the authority to reinvest all profits of the company and not declare any dividends, and this may be clarified under the investment agreement or term sheet executed with investors (we will discuss about termsheets and investment in a later module). 


1. How is dividend computed?

Dividend is declared on face value – for example, a dividend of 10% may be announced by a company. If the face value of a share is INR 100 then the shareholders will earn INR 10 dividend per share. The premium or market value of the share is irrelevant for the purpose of declaration of dividend. 

  1. Companies often issue shares at prices which are much higher than the face value (called a premium). This premium can be many times that of the face value. A premium ranging between 10 to 100 times is common. Thus, a share of INR 100 may be issued at a premium of INR 900.
  2. Market value of a company’s shares may be INR 1500. A person may have purchased shares (of face value INR 100, which were issued for a premium of INR 900) at this market value. These values are irrelevant for the purpose of computing dividends. 

2. How much dividend can a company declare legally?

In general, dividends must be paid out of profits only. Further, dividend must be paid out of current year’s profits ordinarily. In case a company has made losses in the current year (but has accumulated profits of past years), it can declare dividend from accumulated profits (as described later in this chapter).

As per Section 205 of the Companies Act,  the entire amount of profits made in a year could not be paid out as dividend. A certain percentage of the profits had to be transferred to the reserve funds of the company, as per the Companies (Transfer of Profits to Reserves) Rules, 1975.
Under the Companies Act, 1956, the minimum percentage transferred to reserve depends on the quantum of dividend declared, and is represented in the table below:


Amount to be transferred to the reserve before declaring dividend:

Dividend Proposed

(as % of the face value of the share)

Minimum amount that must be transferred to reserves

(% of profits of that year)







More than 20%



Note: This table only specifies the minimum amount of profits that must be transferred to its reserves. A company is free to transfer a greater amount, as explained below.

A company is free to transfer more than 10% of its current profits to the reserve
, provided that if it has declared a dividend, the dividend rate must be at least equal to the average dividend declared in the past 3 years. If it has not declared any dividend, the amount transferred to reserves must be less than the average amount of dividend declared in the past three years.

  1. Can a company declare dividends in a year it has made losses?

    Under the Companies Act, 2013, dividends can be declared if the company has made losses in the current year, if it has accumulated profits from past years (these are usually held as reserves). However, if a company neither has profits nor reserves, no dividend can be declared. Money raised from a fresh issue of shares, through a share premium account or by way of debt capital cannot be used to declare dividend.
The quantum and manner of declaration of dividends from accumulated profits must be in accordance with the following rules laid down in Companies (Declaration and Payment of Dividend) Rules, 2014:

a. The rate of dividend to be paid out should not exceed the average of the dividend paid out in the immediate preceding three years.

b. The amount taken from the reserves for declaration of dividend must be less than one-tenth of its paid up capital and free reserves

c.  The balance amount of the reserves (after taking out the dividend amount) must not be less than 15% of the paid-up share capital of the company.

d. The amount taken out from reserve must be utilized first to set off the losses of that year.

e. Dividend cannot be declared by the company unless the  losses of the previous years are set off against profit of the company of the current year.
 The system for declaration of dividends under the rules made pursuant to the 1956 Act below.

A company must observe requirements under the Companies (Declaration of Dividend out of Reserves) Rules, 1975 impose limits on the amount of dividend that can be declared in such cases.

a. the dividend amount must be lower than the average of the past 5 years dividend rates or 10% of the paid-up capital of the company (whichever is lower);

b. the amount taken from the reserves for declaration of dividend must be less than one-tenth of its paid up capital and free reserves

the balance amount of the reserves (after taking out the dividend amount) must not be less than 15% of the paid-up share capital of the company.

the amount taken out from reserve must be utilized first to set off the losses of that year.


Illustrative Example (based on Companies Act, 2013)
(Students are not required to memorize the conditions or calculation)
Assume that XYZ Electricals Limited has a paid-up capital of INR 80,000 and reserves of INR 20,000. It makes a loss of INR 1,000 in the financial year 2014-2015. The average rate of dividend it has paid out in the past five years is 12%. It intends to declare dividends. What is the maximum amount it can declare?
Since the company has no profits, it will have to declare dividends out of its reserves. The company must ensure that all four conditions a to e mentioned above are satisfied together.
Condition a

The dividend amount must be lower than the average of the past 3 years’ dividend rates

The 3 years’ average dividend rate is 12 percent. Therefore, the maximum rate at which the dividend can be declared must be within 12% of its paid-up capital. Thus, a maximum of INR 9600 can be declared as dividend as per condition a.

Condition b

The amount taken from the reserves for declaration of dividend must be less than one-tenth of its paid up capital and free reserves
Paid-up capital (INR 80,000) and free reserves (INR 20,000) aggregate to INR 100,000. One-tenth of the paid-up capital and free reserves is INR 10,000. As per condition b, amount withdrawn from the reserves must be within INR 10,000.
Condition c
The balance amount of the reserves (after taking out the dividend amount) must not be less than 15% of the paid-up share capital of the company.
15% of the paid-up capital (i.e. INR 80,000) is INR 12,000. After payment of the money from the reserve at least INR 12,000/- must be left in the account as reserves. Therefore, the maximum amount declared can be INR 8,000 as per this condition.

Condition d

The amount taken out from reserve must be utilized first to set off the losses of that year.

Any amount that has been declared must first be used to set-off the losses of that year. Therefore, since the losses are INR 1000, the amount of INR 8000 must first be adjusted against the INR 1000 losses. Therefore, the figure of INR 8000 must be first adjusted against losses of INR 1000, and only INR 7000 can be paid out as dividend.

Condition e

Dividend cannot be declared by the company unless the losses of the previous years are set off against profit of the company of the current year, or loss or depreciation.

As there are no losses in the previous years, nothing needs to be set off under this condition.
Answer: The company can draw a maximum of INR 8000 from its reserves, of which INR 1000 will be used to set-off losses and INR 7000 can be used to pay out the dividend.


Questions for practice:

  1. If the average rate of dividend for 5 years’ was 5 %, what is the maximum dividend it could declare?
  2. If the company had made a loss of INR 5,000, what is the maximum dividend it could have declared?


  1. Time and process of declaration of dividend

The Board must recommend the amount of dividend to be distributed at the annual general meeting of the company (AGM). The Board must propose the dividend. The shareholders have the right at the AGM to approve the recommended rate of dividend or lower the same, but they cannot increase the amount.


  1. Can a company declare dividend at any time during the financial year, or is it mandatory that dividend must be declared at an AGM only?

The Board enjoys a certain level of flexibility with respect to declaration of dividend- it can declare dividend before the completion of the financial year (known as an interim dividend) by passing a resolution for the same. However, the interim dividend must correlate to the profits of the company.

The Companies Act 2013 includes specific provisions for declaration of interim dividend. As per the 2013 Act, the Board can declare interim dividend out of i) surplus in the profit and loss account and ii) out of profits of the financial year in which the dividend is sought to be declared.
Interim dividend can also be declared in a year when the company is making losses (from the profit and loss account) – however, the rate is capped. If the company has made losses in a particular financial year (at least uptil the end of the previous quarter), interim dividend is capped at the average rate of dividend in the previous three financial years. 

Tax on dividend

A company must pay tax on any dividends declared by it. This is known as dividend distribution tax, and is paid at 15% of the amount distributed (which adds up to around 16.995% after adding surcharge and education cess). This is in addition to the income tax paid by the company on its profits (at the rate of 30% for Indian company or 40% for a foreign company operating in India).


Part II – Managerial Remuneration

1. Remuneration of directors

Directors of a company may receive remuneration in the following capacities:


1. Fees for rendering services of a professional nature (i.e. legal or accountancy services)

2. Fees for attending meetings of the board or a committee of the board (known as ‘sitting fees’)

3. Salary, perquisites, dearness allowance, commissions or other allowances in capacity as directors

4. Directors who also hold shares of the company will also receive income related to their shares by way of dividend, or additional benefits related to ownership.


Note: Under the Companies Act, remuneration is defined very widely and includes expenditure incurred by the company in i) providing any rent free accommodation, ii) any amenities provided free of charge or at concessional rates, iii) personal expenses of the directors borne by the company, and iv) insurance, pension and gratuity expenses for the director or even his spouse or child.
Explanation to Section 198, Companies Act, 1956.


A. Provisions common to remuneration of directors private and public companies

Remuneration of directors of private companies is not directly capped under the Companies Act. See Section 309 (9) of the Companies Act, 1956.Private companies are free to regulate remuneration of directors under their articles of association. However, the Companies Act contains provisions requiring disclosures in financial statements and conflict of interest, which apply to both private and public companies, as below:

1. Contractual ceiling on remuneration: The Articles of Association of a company can specify a ceiling on the remuneration of a director.

2. Disclosures on remuneration: A private company is required to make disclosures regarding remuneration paid to its directors in the Notes to Accounts in its financial statements, as per Schedule VI of the Companies Act, 1956 /Schedule III of Companies Act, 2013. Disclosures on remuneration include information related to any payments to directors – e.g. salary, commission, share in profits, perquisites, allowances, etc.

3. Provisions relating to related party transactions/ conflict of interest:

i) The Companies Act prevents directors from indirectly benefiting from their positions as directors of the company. For example, a director may benefit if the company (in which he is a director) enters into a supply contract with another entity in which he (or his relative) has a stake. Such contracts cannot be entered into without taking the Board’s consent. The consent can be obtained either before awarding the contract or within three months of entering into the contract. Under the 1956 Act, if its paid-up capital was more than Rs. 1 crore, it must also obtain Central Government approval (there is no need for approval from the Central Government under the Companies Act, 2013)[1].

Under the 2013 Act, if the paid-up capital of the company is more than Rs. 10 crore, it must  obtain prior approval of the company by a special resolution. Further, there is no requirement to take Central Government any more in case a company meets the paid-up capital threshold specified by the Central Government – a special resolution of the shareholders (other than shareholders who are personally interested) can be taken. If this provision is not complied with, the board can declare such a contract void. Apart from rendering the contract void, any person who has entered into such contract in violation of the provisions, in case of a listed company, the person responsible can be imprisoned for a period of one year and or with a minimum fine of Rs 25 thousand and may extend to ` 5 lakhs. For other companies, fine of similar amount will be applicable. Recently, the world’s largest market research firm Nielsen was fined Rs. 1 lakh for not complying with the above requirement.

[1] See Section 297 of the Companies Act, 1956/ Section 188 of the Companies Act, 2013


ii) The director is also under a duty to disclose to the company if he has a personal interest in any contract the company is likely to enter into. He cannot vote on matters related to such dealings in board meetings. 

iii) A director and his relatives or partners are also prohibited from holding any other office of profit without consent of the shareholders by a special resolution, i.e. 75% shareholders in a general meeting. Appointment to the post of managing director/ manager, banker, or trustee for debenture holders of the same company (or its subsidiaries) is the only exception and does not require such shareholder consent.


  • As per the new Companies Act, 2013 this requirement will not be applicable to private companies. 

Severance Packages / Golden Handshakes 

A director is usually also an employee of the company. What happens when a director is removed from employment or fired?

The world of Mergers & Acquisitions (M&A) is replete with instances of golden handshakes – i.e. employment contracts with directors which provide for exorbitant payments to them from the company in case their services are terminated. This is a mechanism to protect their contract with the company, and is also a deterrent for an acquirer because it makes an acquisition more expensive (known as a takeover defense) – most strategic acquirers (and private equity funds who impose their own management team on the target company) will have to pay significant money in case they fire the director post the acquisition. For example, the Nokia Chairman defended a USD 24 million golden handshake compensation package for the Nokia CEO, which would get triggered if he was fired post the Microsoft Acquisition (click here to read the story). 

As per the Companies Act, 2013, a company is allowed to pay compensation to whole-time directors, managing directors or managers compensation for loss of office when his services are terminated. Severance pay should be based on the average remuneration earned in the past three years (for each year), and the aggregate payment should not exceed the amount that would have been paid if the director was in office for 3 years, or remainder of his term, whichever is less.
Employment contracts with directors which stipulate a higher severance package than what is permissible under the Companies Act 2013 will not be enforceable.


Assume a managing director who was appointed for a period of 5 years. He drew 12 lakhs, 13 lakhs and 14 lakhs in the past 3 years. His average salary is, therefore, INR 13 lakhs. If his services are terminated in the event of an acquisition, he can receive a maximum severance package of INR 13 lakhs x 2 (i.e. the number of service years remaining or 3 years, whichever is lower) = INR 26 lakhs.

 However, no severance payments are permissible when:
  • a director whose services are terminated post restructuring or amalgamation is re-appointed as the MD, manager or whole-time director of the amalgamated or restructured company. Further
  • the company
  • the director has committed fraud, gross negligence, gross mismanagement or winding up arising out of default or negligence of the director
  • the director has acted in such a manner that it has directly or indirectly led to his removal from office
  • voluntary resignation of the director
  • he is disqualified under the Companies Act, 2013 to continue as a director due to non-disclosure of interest with respect to related party transactions, absence in board meetings, etc. (see Section 167 of the Companies Act 2013)


    Note: Removal from employment does not lead to relinquishing or confiscation of the director’s shareholding – any shares held by the directors can be continued to be held, unless the contract provides for some way to acquire the shares, in which case they may be bought back by the company or acquired by an existing shareholder based on a valuation. When Steve Jobs was fired as the CEO of Apple, he still continued to hold his shares, which he subsequently sold on the exchange out of his free will. 


3. Provisions affecting remuneration of directors of public companies only
As mentioned earlier, remuneration to directors of public companies is heavily regulated by the Companies Act. The total remuneration payable to directors of a public company (or a private subsidiary of a public company) must not be more than 11% of the net profits of the company for that financial year. See Section 198, Companies Act, 1956. However, this limit does not includesitting fees’, that is, the amount paid to directors for attending meetings. We are covering some key issues related to director’s remuneration below:


i. Which legal documents must specify the remuneration of public company directors?

The remuneration payable to the directors (including the managing or whole time director) must be determined either by the articles of the company, or by an ordinary resolution of shareholders (if the articles are silent). If, the articles stipulate that remuneration must be determined by a special resolution of shareholders, then an ordinary resolution will not be sufficient.

Every public company which has a paid up share capital of Rs. 5 crores must have a managing or a whole time director or a manager. The terms of appointment of such a director or manager must be as per the conditions specified in Schedule XIII of the Companies Act. In case of any deviations from the conditions in Schedule XIII, specific approval must be taken from the Central Government to appoint such person as a managing director or whole time director.

 What are the limits for remuneration payable to directors?

Remuneration payable to directors of a public company is dependent on whether the company has made profits. If it has made inadequate profits or if it has made losses, then the ceiling on remuneration is linked to the capital of the company.

i) Ceiling on payment of managerial remuneration in case of profits (both under old and new Companies Act)

If a company has made profits in a particular financial year, the ceiling on remuneration is dependent on the profits, and is represented by the table below:


Category of Directors

No. of directors in the relevant category

Remuneration ceiling (based on percentage of net profit in a particular financial year)

All directors taken together

(includes those in whole-time or part-time employment and the managing director)

As per the Companies Act 2013, the ceiling of 11 percent remuneration for all the directors combined can be removed and a higher ceiling may be determined with the approval of the Central Government.





Whole time directors/ Managing director

As per the new Companies Act 2013, these limits can be increased with the approval of shareholders in a general meeting. 



If one





If multiple




Part-time directors

As per the new Companies Act 2013, these limits can be increased with the approval of shareholders in a general meeting.


If the company has a managing or whole-time director or manager





In other cases (i.e. if the company does not have a whole-time director or manager)






NoteFees paid to directors for rendering professional services will not be governed by the above caps if in the opinion of the Central Government they possess requisite qualifications for practising the profession. For example, accountancy services provided by a director who is a Chartered Accountant would qualify as professional services.

  1. Ceiling on payment of managerial remuneration in case of losses (both under old and new Companies Act)

Where a company has made losses, the maximum monthly remuneration is capped, based on the ‘effective capital’ of the company. (As per the Companies Act, the term effective capital has a specific definition. It is arrived at by adding paid-up share capital, share premium, reserves and long-term loans and subtracting investments and losses.)

These limits have been modified under the 2013 Act.

The ceiling on remuneration as per the 1956 Act is given in the table mentioned below:

Effective Capital

Monthly remuneration ceiling per director

(subject to conditions 1 and 2 below)

Monthly remuneration ceiling per director

(subject to special resolution of shareholders)

Less than INR 1 crore

INR 75,000

INR 1.50 lakhs

INR 1 – 5 crores

INR 1,00,000

INR 2 lakhs

INR 5 – 25 crores

INR 1,25,000

INR 2.5 lakhs

INR 25 – 50 crores

INR 1,50,000

INR 3 lakhs

INR 50 – 100 crores

INR 1,75,000

INR 3.5 lakhs

> INR 100 crores

INR 2,00,000

INR 4 lakhs

  • Condition 1: The Remuneration Committee (a committee comprising of certain members of the board of directors) should approve the remuneration by a resolution.
  • Condition 2: There should not be any default in repayment of any of its debts or public deposits or debentures or interest for a continuous period of thirty days in the preceding financial year before the date of appointment of such managerial person.

Remuneration in excess of the third column in the table above will require Central Government approval.

[For further reference, see Sections 198, 269, 309, 310, 311 and Schedule XIII of the Companies Act, 1956]

Ceilings under the new Companies Act, 2013
The Companies Act, 2013 has altered the limits, as below:

Effective Capital Yearly remuneration ceiling per director
Applicable if the company has obtained a resolution of the Board of Directors (and resolutions of the Nomination and Remuneration Committee, where applicable) and not defaulted in repayment of debts.
Yearly remuneration ceiling per director
[These limits are applicable if:
1) Special resolution of shareholders is obtained, the ceilings will double)
2) Or the company is less than 7 years old (calculated from the date of incorporation).]
Less than INR 5 crores INR 30 lakhs INR 60 lakhs
INR 5 – 100 crores INR 42 lakhs INR 84 lakhs
INR 100 – 250 crores INR 60 lakhs INR 120 lakhs
> INR 250 crores INR 60 lakhs + 0.01 percent of effective capital in excess of INR 250 crores INR 120 lakhs + 0.02 percent of the effective capital in excess of INR 250 crores

(see Sections 197-198 and Schedule V of the Companies Act, 2013)

For further reference, refer:

  • Sections 167, 197-198, Companies Act 2013
  • SchedulesIII, Vof the Companies Act 2013

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