The Government has moved one step closer to introducing its much discussed amendments to the payment of dividends test in the Corporations Act 2001 (Cth) (“Corporations Act”) with the recent release of an Exposure Draft Bill for public consultation (“Exposure Draft”). An Explanatory Memorandum relating to the changes outlined in the Exposure Draft ("EM") has also been released.
The Exposure Draft builds upon the previous announcements that the Government has made with respect to amendments to the test for paying dividends. King & Wood Mallesons has previously published alerts which consider the development of the dividends test, which are available here and here.
Current test for payment of dividends
Section 254T of the Corporations Act currently provides that a dividend may only be paid where:
- the assets of the company (as determined in accordance with accounting standards in force at the time) exceed its liabilities and, immediately before the dividend is declared, 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.
Such a test is referred to as a “net assets” test. It has, since June 2010, replaced the “profits-based” test which applied in Australia under the former section 254T of the Corporations Act.
As outlined in our earlier alert, in a discussion paper issued on 28 November 2011 (“Discussion Paper”), various concerns were raised by stakeholders in respect of the current “net assets” test for paying dividends. In particular, the Government recognised:
- the unreasonable burden placed on some companies (in particular, companies that are not generally required to comply with accounting standards in the ordinary course) by the use of accounting-based calculations in determining whether assets exceed liabilities for the purpose of paying dividends;
- the insufficient relationship that the “net assets” test has with solvency;
- the use of the word “declared” rather than “determined” in respect of the timing of the “net assets” test;
- the inter-relationship between the “net assets” test and the capital maintenance requirements in the Corporations Act; and
- the operation of the franking arrangements for dividends.
Key changes proposed to the payment of dividends test
As a result of the issues identified in the Discussion Paper, the Exposure Draft proposes to repeal the current test and replace it with a test that:
- allows companies to either declare or determine a dividend, consistent with Corporations Act dividend provisions and company practice;
- allows companies to calculate assets and liabilities based on existing reporting requirements (thereby allowing certain entities to calculate assets and liabilities with reference to financial records, rather than accounting standards); and
- requires the directors of a company to reasonably believe that the company will be solvent immediately after the dividend is declared or paid.
This is, in essence, the “solvency test” which was proposed in the Discussion Paper.
If enacted, the new section 254T will apply to dividends declared or paid from the date the enabling legislation receives Royal Assent. Where a company declares a dividend that has not been paid prior to the commencement of the new law, the current law will continue to apply.
The EM notes that the proposed changes to section 254T are not intended to displace the existing requirements in relation to conducting share capital reductions and share buy-backs under Chapter 2J of the Corporations Act. The changes are also not designed to change taxation arrangements for dividends.
The EM further notes that proposed new section 254T will apply to all dividends paid pursuant to the Corporations Act. The treatment of dividends under other legislation will continue to apply in their current form.
Will the “new” amended section 254T overcome the deficiencies of the “old” amended section 254T?
The new payment of dividends test goes some way in responding to the concerns raised by stakeholders regarding the current “net assets” test contained in section 254T of the Corporations Act. In particular, it links the test more strongly with company solvency and provides concessionary relief for companies that are not required to prepare audited financial reports.
However, the proposed new test does not do away with the “net assets” test as was recommended by a number of stakeholders in response to the Discussion Paper. Rather, it clarifies that the test is a “net assets and solvency” based test. Such amendments will not help certain companies (such as infrastructure companies) who, whilst clearly solvent, may have negative net assets because, for example, they are unable to revalue them under the accounting standards. There is nothing in the new test that allows directors to rely on valuations of assets and estimates of liabilities that they consider reasonable in the circumstances (which was recommended to the Government). These companies may continue to be unable to pay dividends under section 254T.
Further, the EM notes that the new dividends test does not displace the existing requirements in the Corporations Act relating to share capital reductions and share buy-backs. However, despite such a claim:
- the proposed new section 254T (as contained in the Exposure Draft) does not say anything as explicit as this; and
- such a statement is inconsistent with previous comments made by the Government on the issue, both in the Discussion Paper and the explanatory materials that introduced the current section 254T into the Corporations Act. Previous comments indicted that following the June 2010 amendments, section 254T was intended to operate as an exception to the capital maintenance rule and suggested that it may not be necessary for an authorised dividend payment that includes an amount of share capital to also satisfy the requirements of Chapter 2J of the Corporations Act.
Accordingly, given the statements in the EM and the lack of any specific statements in the draft legislation, the inter-relationship between the test for paying dividends and the capital maintenance requirements in the Corporations Act would seem to be as uncertain as ever.
However, if section 254T is amended as proposed and the provisions in Chapter 2J are required to be complied with upon payment of a dividend that includes an amount of share capital (which would seem in line with the comments in the EM), then it would nonetheless appear that the test for paying dividends will effectively return to a “profits-based” test but with additional restrictions on the ability to pay dividends that were not present before section 254T was amended in June 2010.
A “profits-based” test for the payment of dividends would be consistent with the views expressed by the Australian Taxation Office in Taxation Ruling TR 2012/5. In that tax ruling, the Commissioner of Taxation set out his view that for the purposes of the Corporations Act and company accounting, dividends can only be paid from profits. The Commissioner’s view was based on legal advice received from Counsel which, following the Exposure Draft, now appears to be the accepted position regarding the payment of dividends in Australia.
Finally, if there is intended to be an effective return to a “profits-based” test for the payment of dividends then it is curious that the Exposure Draft does not propose to repeal section 44(1A) of the Income Tax Assessment Act 1936 (Cth). Section 44(1A) was introduced when section 254T was amended in June 2010 and deems dividends paid out of amounts other than profits to have been paid out of profits for income tax purposes. The return of a profits-based test for the payment of dividends would, however, leave section 44(1A) with little to no application.
Other measures contained in Exposure Draft
In addition to amending the test for the payment of dividends, the Exposure Draft contains measures to:
- enhance the disclosure of executive remuneration in Australia;
- strengthen Australia's corporate governance framework by requiring companies to disclose their claw-back policy in the event of material misstatement;
- remove inconsistencies in auditor appointment; and
- improve consistency of remuneration setting for accounting boards.
Timing and consultation
It is unclear from the Exposure Draft when the Government’s intends to introduce a Bill into Parliament to refine the new test for the payment of dividends in Australia.
However, in a Media Release issued by the Parliamentary Secretary to the Treasurer on 14 December 2012, the Government announced that it encourages comment and feedback on the Exposure Draft and invites interested stakeholders to provide their input. The Government has called for submissions on the Exposure Draft by 15 March 2013.