In a tight market for capital, investors are demanding a higher dividend yield for the price of their investment. Dividend payout ratios are rising as companies look to maximise shareholder value and meet investor expectations.

In practice, paying a dividend is not straightforward. We share our insight in this publication on the hurdles faced by companies paying dividends, and key considerations to paying a dividend.

Why does paying a dividend require careful consideration?

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A dividend may only be paid by an Australian entity if specific requirements are met.

Section 254T of the Corporations Act 2001, common law and each company's respective constitution govern the ability of companies to pay a dividend to shareholders. The operation and interpretation of the law means that corporate structures with multiple companies need to consider carefully the legal, accounting and tax interplay when setting dividend policies and paying dividends to shareholders.

A company's ability to pay a dividend is assessed on a single entity basis. As such, while a company might be part of a tax consolidated group for income tax purposes (whereby intercompany transactions are generally ignored and the franking credits reside with the 'head company'), the entity proposing to make a distribution will still need to meet the requirements outlined above. This means that despite recording healthy profits across the group, the legal and accounting interactions can still result in dividend 'traps' in complex corporate structures.

Below are some common "symptoms" that we have seen in companies that suggest an incapacity to pay dividends:

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What if a company has paid a dividend that doesn't satisfy the requirements?

The consequences of such a payment will depend on the particular circumstances, but may include that:

  • the dividend is treated as an unauthorised return of share capital;
  • the dividend is characterised as a loan; and/or
  • there has been a contravention of the Corporations Act or common law.

It should also be noted that any such distribution is unlikely to be "frankable" for tax purposes.

Case studies of Australian companies which exhibited "symptoms"

Consider the scenarios below where the company would not have been able to pay a dividend legally without taking the "Actions" we recommended:

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