Amendments to the Corporations Act concerning the payment of company dividends

The Corporations Amendment (Corporate Reporting Reform) Act 2010 (CRR Act) amends the Corporations Act 2001 (Act) by changing the 'profits' test that has previously applied to the payment of company dividends. Before the amendment came into effect on 28 June 2010, section 245T of the Act applied a 'profits test'; that is, dividends could only be paid out of the profits of the company. The CRR Act has changed the requirements that must be met before a dividend can be paid to a solvency based test.

Background

The amendments were initiated in response to industry concerns that the previous system was not consistent with modern accounting principles. In December 2002, the Australian Accounting Research Foundation recommended that a solvency test should be adopted instead of the profits test. The criticisms of the profit approach were mainly that it was too difficult to apply due to a lack of a definition of the term 'profits'. The Act did not define the term 'profits' nor provide any guidance on the operation of the 'profits test'. Further, ASIC reports indicated that smaller companies lacked the resources to comply with the reporting requirements of the Act. The changes proposed would enable a small company that is not required to prepare an audited financial report, to determine its solvency by reference to the accounting records it is required to keep under section 286 of the Act.

The CRR Act amendments were introduced for a number of reasons, including:

• to reduce the regulatory burden on small companies by establishing a specific financial reporting regime;
• to clarify when a company can cancel its share capital;
• to require all listed entities to disclose a review of operations and financial conditions; and

• to modify the requirement that companies may only pay dividends from profits by replacing the current 'profits test' with a 'solvency test' (or, as it otherwise known, a 'balance sheet test').

The dividend amendments to the Act

Under the new section 254T of the Act a company will be able to pay dividends where:

• the company's assets exceed its liabilities and the excess is sufficient for the payment of the dividend;
• payment of the dividend is fair and reasonable to the company's shareholders as a whole; and
• payment of the dividend does not materially prejudice the company's ability to pay its creditors.

For the purpose of the new section, assets and liabilities are calculated in accordance with the accounting standards that apply when the dividend is declared. The accounting standards will need to be considered by all companies, especially small unaudited proprietary companies, because the application of accounting standards may produce a different result to that achieved in non audited accounts (eg recognitions of assets and liabilities, write downs for impairment).

Companies should consider whether the new amendments will affect the provisions of their company constitution concerning the payment of dividends to members. We recommend that companies review their constitutions in order to ensure they comply with the new dividend requirements. As a result of the amendments, if the constitution provides that dividends are to be paid out of profits, the company will need to satisfy both the profits test and the new balance sheet test.

Directors should ensure that in considering whether to declare a dividend:

1. the payment will not result in the company being unable to pay its debts;
2. the payment is not an act of insolvent trading for the purposes of s588G of the Act; and
3. if the company is in a difficult trading or financial position, the payment of a dividend will not jeopardise the company's viability now or in the future.

Authored by Ian Sinclair and Luca Sbardella, Cornwall Stodart