Australia reviews dividend regime

In June 2010, Australia’s federal government amended the Corporations Act 2001 (Cth) to replace the profit-based test in section 254T with a three-tiered test for determining whether a company can pay dividends. The introduction of this new test has created significant accounting and tax problems. In response, the government released a discussion paper, Proposed Amendments to the Corporations Act, which canvasses options for reworking these dividend rules. Submissions on the discussion paper closed on 30 January, and further amendments to the legislation may be expected during 2012. The discussion paper suggests various options to overcome the complexities that arise under the current section 254T.

The current test

A company must not pay a dividend unless:

• the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend;
• the payment is fair and reasonable to shareholders as a whole; and
• the payment does not materially prejudice the company’s ability to pay its creditors.

The discussion paper

Concerns identified in the discussion paper include:

• linking the dividend test to the accounting standards places an unreasonable burden on those companies that are not otherwise required to comply with the standards;
• an “assets greater than liabilities” test is inappropriate – it has little relationship to solvency because it does not take into account the timing and magnitude of flows of funds;
• use of “declared” in section 254T compared to “determined” in section 254U (if a company’s constitution provides for dividends to be “declared”, and a dividend is declared, the company incurs the debt at that time rather than when the time for payment of the dividends occurs);
• the inter-relationship between the dividends test and the capital maintenance requirements in chapter 2J of the Corporations Act – that is, whether paying a dividend in a manner that complies with section 254T can be out of share capital, or whether the requirements in chapter 2J dealing with returns of share capital, including shareholder approval, must be satisfied; and
• the interaction of section 254T with the franking credit rules in the tax law – that is, whether a dividend that creates or increases a deficiency of net assets below share capital is frankable for tax purposes.

The four options

Four options are canvassed in the discussion paper for “dealing with the dividends test”:

Option 1 – no change: section 254T would be retained as currently drafted. The discussion paper acknowledges that this approach does not address the difficulties identified with the new section 254T, including that companies that do not need to comply with some or all of the accounting standards will need to have regard to them (and incur the cost of doing so) before paying a dividend.

Option 2 – introduce a solvency test: under this option, a company must not pay a dividend unless the directors are satisfied that the company’s assets will exceed its liabilities after the dividend is “declared”, and that the company will continue to be able to pay all the company’s debts, as and when they become due and payable (the “solvency test”).

Option 3 – reinstate the former profits test: this option proposes to return to the position before the 2010 reforms, where a dividend could only be paid out of a company’s profits. The discussion paper acknowledges that this would do little to overcome the problems identified in relation to the old section 254T – namely, the absence of a definition of “profits” and the move to fair value accounting.

Option 4 – give a choice between a profits test and a solvency test: this option provides a company with a choice of either complying with the old section 254T (only out of profits) or the current section 254T (the three-tiered test).

Other issues

The discussion paper also notes the following:

• The use of the term “declared” in section 254T has created some confusion. Unfortunately, the Department of the Treasury still proposes to use the phrase “declared” if the dividend test includes a solvency test. However, it would seem appropriate that the time for assessing whether the payment of a dividend would imperil a company’s solvency is the time when the debt arises – i.e. either upon declaration or when the time for payment arrives (where the dividend is “determined” rather than declared).
• Paying a dividend in accordance with section 254T is a circumstance where a reduction in share capital is “otherwise authorised by law”, and therefore is permitted under section 256B (1) without shareholder approval.
• Amendments may be required to clarify the manner in which the net assets test is applied to company groups. One concern raised is that a parent company may not be able to access profits made by a subsidiary if an intermediate holding company cannot satisfy the net assets test.
• The franking of dividends that creates or increases a deficiency of net assets below share capital is still unresolved, but is expected to be dealt with in an Australian Taxation Office (ATO) ruling. The ATO’s position indicated in a draft tax ruling is that a dividend paid without breaching section 254T will be frankable if it is either paid out of current year profits or unrealised capital profits recognised in a revaluation reserve, provided the company’s share capital is intact; dividends other than those debited to current year profits will not be frankable to the extent that they create or increase a deficiency of net assets below share capital.

Action points

Companies should review the discussion paper and consider the four options canvassed in relation to the dividends test. They should also identify any issues or concerns with the four options or other issues raised in the discussion paper.