This paper was co-authored by Kellie Cook, Senior Associate
On 10 April 2014, the exposure draft of the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 was released for comment. The Bill is part of a package of measures introduced by the Government to repeal and streamline the Corporations Act 2001 (Cth) and reduce compliance costs for businesses.
The Bill proposes a new test for the payment of dividends which may necessitate changes to a company’s constitution and board policies.
The consultation period ends on 16 May 2014 and the Bill is expected to be introduced in the 2014 Autumn/Winter Sittings of Parliament.
The current test
Section 254T of the Corporations Act (which has been law since 28 June 2010) is a net assets test and provides that 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 of the dividend is fair and reasonable to the company’s shareholders as a whole; and
- the payment of the dividend does not materially prejudice the company’s ability to pay its creditors.
However, the existing net assets test is arguably not an effective measure of a company’s solvency.
Prior to this test a dividend could only have been paid out of the profits of the company.
The new test
The Bill proposes replacing the above three limb test with a pure solvency test. The proposed new section 254T provides:
- “A company must not declare a dividend unless, immediately before the dividend is declared, the directors of the company reasonably believe that the company will, immediately after the dividend is declared, be solvent.
- A company must not pay a dividend unless, immediately before the dividend is paid, the directors of the company reasonably believe that the company will, immediately after the dividend is paid, be solvent.”
The new provision clarifies that (b) above will not apply to a dividend that is declared.
The new test is to be welcomed as a much simpler test. The proposed new section 254T also removes some of the practical difficulties with the current test (for example, see below in relation to capital reductions). It will also reduce compliance costs in calculating a company’s assets and liabilities in accordance with accounting standards, particularly for those companies that are not required to prepare audited financial statements.
Clarification of the reduction of capital rule
The current test does not permit a distribution that amounts to a reduction of share capital. Chapter 2J of the Corporations Act imposes additional conditions on such reductions (capital maintenance provisions), particularly the requirement to obtain shareholder approval.
The proposed section 254TA provides that a “company may reduce its share capital by declaring or paying a dividend, if (a) the dividend is declared or paid, as the case may be, in accordance with section 254T; and (b) the reduction in share capital is an equal reduction.” Therefore, the new test exempts dividend payments from the capital maintenance provisions to the extent that they are “equal reductions” in capital as opposed to “selective reductions” which may benefit some shareholders more than others.
The new test is much simpler and expands the circumstances in which a company can pay a dividend. The change may also assist in facilitating corporate restructures via in specie distributions of shares without shareholder approval.
The proposed changes are not intended to change existing company taxation arrangements. However, if implemented, companies will need to carefully consider the taxation implications of paying a dividend other than out of profits.
For more information on this update please contact Emma Leys on (08) 9321 3755.
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