HG Corporate Advisory & Governance Alert: Proposed changes to the test to pay dividends - six key consequences for companies – 13 May 2014

Proposed amendments to section 254T of the Corporations Act 2001 (Cth) (Corporations Act) will change the test for when a company can pay dividends from a “Balance Sheet” or “Net Assets” test to a “Solvency” test. 

The proposed changes will also confirm that dividend payments under section 254T will be exempt from the capital maintenance provisions if they are an “equal capital reduction” (as opposed to a “selective capital reduction”). 

In this Alert Michael Hansel, Partner and Katherine Hammond, Associate set out the six key consequences for companies of the proposed changes to the dividends test.

Key Points

  1. The proposed test for paying dividends is a “Solvency Test”, where the directors must reasonably believe at both the time they declare and pay a dividend, that the company will be solvent after the respective declaration and payment;
  2. Companies will be allowed to reduce share capital through dividend payments; and
  3. The proposed new test may have administrative, corporate governance and other consequences for companies such as in relation to the company’s constitution, policies and accounting procedures.

Six key consequences of the proposed changes

  1. The test will be a “Solvency Test” and not “Profits” or “Net Assets” Test which therefore expands the circumstances in which a company can pay a dividend (see below).
  2. Companies will be allowed reduce share capital through dividend payments (see below).
  3. Directors will be required to include details about the source of dividends paid and the company’s dividend policy in the Annual Director’s Report when paid out of sources other than profits. 
  4. The new Solvency Test may reduce compliance costs of calculating a company’s assets and liabilities in accordance with accounting standards.
  5. Companies may need to update their constitutions and board policies regarding dividends.
  6. The changes may enable a corporate restructure without shareholder approval, where a company could make an in specie distribution of shares it holds in a subsidiary, to a parent company (or shareholders), as a dividend payment.

Dividend tests

a) Proposed New Test – “Solvency”

The proposed new test is a pure “Solvency Test” where:

  1. A company must not declare a dividend unless, immediately before the dividend is declared, the directors of the company reasonably believe that the company will, immediately after the dividend is declared, be solvent; and
  2.  A company must not pay a dividend unless, immediately before the dividend is paid, the directors of the company reasonably believe that the company will, immediately after the dividend is paid, be solvent. 

Under section 95A of the Corporations Act, solvency means being able to pay debts when they are due and payable.

b) Current Test – “Net Assets”

The current test for payment of dividends is a “Net Assets” test where dividends may be paid by a company only if:

  • The company has positive net assets following the payment of a dividend;
  • The payment is fair and reasonable to the company’s shareholders as a whole; and
  • The payment does not materially prejudice the company’s ability to pay its creditors.

The net assets are to be calculated in accordance with accounting standards, which places a compliance burden on companies that are not otherwise required to apply accounting standards.

c) Previous Test – “Profits”

The Net Assets Test was introduced on 28 June 2010.  Before the Net Assets Test, the test was a “Profits Test” where companies could only pay dividends out of profits calculated according to accounting standards.  That change was motivated by the fact that:

  • there was no clear legal definition or interpretation of “profits”;
  • as a result of the accounting standards, a company with sufficient cash to pay a dividend may not be able to do so because of non-cash expenses; and
  • there has been a trend towards lessening the capital maintenance doctrine.

Capital Maintenance Provisions

The capital maintenance provisions in section 256B of the Corporations Act require (among other things) shareholder approval for a company to reduce its share capital (equity) in a way that is not otherwise authorised by law.

The prevailing view (which to date has limited the utility of the Net Assets Test) is that the consequence of the capital maintenance provisions on section 254T is that shareholder approval is required where a company would reduce its share capital by paying dividends otherwise than out of profits.  The proposed amendment is required in order to ensure that a company is entitled to reduce share capital by paying a dividend otherwise than out of profits under the new Solvency Test regime without requiring shareholder approval. 

The proposed changes will include a new section 254TA which confirms that dividend payments under section 254T will be exempt from the capital maintenance provisions if they are an “equal capital reduction” (as opposed to a “selective capital reduction”). 

Timeframe for review

The proposed amendments are part of a broader package of deregulatory amendments to the Corporations Act and Australian Securities and Investments Commission Act 2001 (Cth) designed to reduce compliance costs for business.
An exposure draft of the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 containing the proposed amendments was released on 10 April 2014.

There is a consultation period on the exposure draft which ends on 16 May 2014 with the Bill expected to be introduced in the 2014 Autumn/Winter sittings of Parliament.

For more information on the consequences of the changes on your company, please contact a member of our Corporate Advisory and Governance group.

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