Changes to Paying Company Dividends

Changes to Paying Company Dividends



Changes To Paying Company Dividends

Company dividends: Changes to when dividends can be paid

The Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth) came into effect on 28 June 2010. It has new implications for when companies can pay dividends to shareholders.

These new rules in section 254T(1) of the Corporations Act 2001 provide that a dividend may only be paid where:

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

Under the old requirements, dividends could only be paid out of “profits”.

The new test requirements

The new rules were designed to create a regime with greater flexibility for companies. However, the changes have created other potential difficulties for companies wishing to pay dividends.

Accounting standards

Under the new “balance sheet test”, an assessment of the company’s balance sheet must be made in accordance with accounting standards. This will not be difficult for larger companies who are accustomed to preparing financial reports in line with the AASB accounting standards. However, this requirement creates extra compliance costs for small companies who are not generally required by law to produce audited financial reports of AASB accounting standards. Consequently, such companies may be forced to pay for expert accounting advice to determine whether they can pay a dividend.

Declaring dividends

Under the new rules, the “balance sheet test” is applied immediately before the dividend is “declared”. Once a dividend is “declared” by a company it immediately becomes a debt owed to the shareholders, rather than at the time of payment. For this reason, many company constitutions do not contain provisions to “declare” a dividend, instead they implement provisions to determine that a dividend is payable. Directors should now ensure their company constitutions are reviewed so that they are able to declare dividends. To manage concerns relating to creating a debt owing to shareholders, directors could determine a dividend payment and then declare it immediately before the scheduled time of payment.

Fair and reasonable

Companies which have different share classes with different dividend entitlements will need to consider whether a dividend payment satisfies the new “fair and reasonable test” – particularly where a dividend is proposed to be paid to one class of shareholders whilst excluding other classes of shareholders.  It is currently unclear exactly what factors need to be taken into account as the term “fair and reasonable” has not been defined in the dividend context. 

To prevent any potential challenge by a non-recipient shareholder that the dividend payment is not fair and reasonable, directors should review dividend rights attached to all classes of shares and consider their justification if paying differential dividends.

Share Capital Reduction Requirements

It is also not clear as to whether the new rules will allow a reduction of share capital by declaring a dividend, without also satisfying the share capital reduction rules in Chapter 2J of the Corporations Act 2001.

Constitutional amendments

Many company constitutions contain provisions based on the old “profits test”. These companies should consider amending their constitutions to remove the outdated profit requirement and also clarify the timing of declaration of a dividend to determine when the declaration will become a debt owing to shareholders.

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