In mid-2010 the age-old profits test for declaration and payment of dividends was replaced with a balance sheet test. Now draft legislation has been released which, if enacted, will change the test again.
The Government has recently released for consultation exposure draft legislation and explanatory material which, among other things, contemplates amendments to section 254T of the Corporations Act 2001 (Cth) (the Act) which deals with the declaration and payment of dividends.
Prior to June 2010, section 254T of the Act provided that a dividend could only be paid out of a company’s profits.
The intention of the proposed amendments is to address concerns which arose from the replacement of the “profits test” with the “balance sheet test”. Those concerns included:
- that by linking the test to the accounting standards unreasonable burdens were being placed on companies that are not required to comply with the accounting standards (e.g. small proprietary companies that do not have to prepare financial statements)
- that the balance sheet test has an insufficient relationship with solvency
- the uncertainty created by the use of the word “declared” rather than “determined” in respect of timing
- the uncertain interaction with the capital maintenance requirements of the Act.
The balance sheet test
The current provisions of section 254T of the Act provide that a dividend may only be paid where:
- assets exceed liabilities and the excess is sufficient for the payment of the dividend, immediately before the dividend is declared
- 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.
Assets and liabilities are to be calculated in accordance with accounting standards in force at the relevant time (even if the standard does not otherwise apply to the financial year of some or all of the companies concerned).
The new test
The draft legislation contemplates the repeal of the existing test under section 254T and its replacement with a new test.
Under the proposed new legislation, a company must not declare (or pay) a dividend unless, immediately before the dividend is declared (or paid):
- the company’s assets exceed its liabilities, and the excess is sufficient for the payment of the dividend, and
- the directors of the company reasonably believe that the company will, immediately after the dividend is declared (or paid), be solvent.
Assets and liabilities are to be calculated in accordance with:
- the accounting standards in force at that time, where a company is required to prepare a financial report; or, if not applicable
- the most recent financial records of the company.
Whilst arguably not perfect, the new test goes a long way to addressing many of the concerns raised in relation to the balance sheet test. In particular from an SME perspective, the simplification of the accounting requirements will help reduce administrative burdens for many companies. Curiously, the requirement that the payment of the dividend is fair and reasonable to the company’s shareholders as a whole has been removed with no supporting rationale in the explanatory material.