Dividend payout ratios are rising as companies look to maximise shareholder value. Changes to the Corporations Law in 2010, subsequent ATO guidance and the accounting rules have created challenges for companies to meet market expectations for paying franked dividends.
In 2013, Australian companies paid out a record US$40.3 billion in dividends, an increase of 10.2 per cent year on year.1 In a challenging market for capital growth, dividend payout ratios have increased as companies look to meet investor expectations for higher yields and to maximise shareholder value.
In a tough competitive environment, companies face many challenges to grow business and profits and keep up with the yield trend. It is therefore critical that corporate structures do not hinder the ability to flow dividends to ultimate shareholders. There are many tax, accounting and corporate law considerations to work through to facilitate this goal.
In June 2010, the Corporations Act 2001 (Cth) (Corporations Law) was amended replacing a ‘profits test’ with a ‘solvency test’ for paying dividends. The current test in section 254T of the Corporations Law now prescribes that a dividend must not be paid unless:
- a company’s assets exceed its liabilities;
- it is fair and reasonable to all shareholders; and
- creditors will not be materially prejudiced by the payment of the dividend.
The broad objectives of the changes were to provide greater flexibility to companies to distribute dividends. This was particularly targeted at circumstances where there were no current year profits and/or retained earnings. Notwithstanding these broad objectives, uncertainties remained as to when a company could pay franked dividends.
After seeking Senior Counsel Opinion, the Commissioner of Taxation expressed his view in Taxation Ruling TR 2012/5 that the need for profits to pay dividends was not abolished by the introduction of the new section 254T. In the Commissioner’s view, section 254T was not an enabling provision, rather it provided a prohibition against paying dividends unless the relevant tests were met. According to the Commissioner, the concept of profits as the source of a dividend payment continues to be relevant to the payment of a dividend in compliance with section 254T and to the assessment and franking of dividends for taxation purposes. It follows therefore that a dividend which does not comply with section 254T should, in the Commissioner’s view, be treated as a return of share capital and taxed as a capital gains tax event (under the CGT provisions of the income tax law) or, as an assessable unfranked dividend.
The impact of this is that corporate structures with multiple companies need to consider carefully the legal, accounting and tax interplay when setting dividend policy and looking to flow franked dividends to ultimate shareholders. Whilst for income tax purposes, a company might be part of a tax consolidated group meaning intercompany transactions are generally ignored and the franking credits reside with the ‘head company’, section 254T applies on a single entity basis meaning the Corporations Law and accounting interactions can result in dividend ‘traps’. With this in mind, it is important that Chief Financial Officers (CFOs) and their finance teams work collaboratively with their tax and legal advisers to ensure their corporate structure operates efficiently, and does not impede on the ability to distribute franked dividends or maximise yield and value for shareholders.