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Recent amendments to the Corporations Act 2001 (the Act) have made changes to how dividends can be declared and paid by a company.

As a result of the amendments now under the Act, companies are only permitted to declare and pay a dividend where:

  • the company’s assets exceed its liabilities immediately before the dividend is declared and 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.

Before these changes only the available profits of the company were relevant to this permission. The changes have effectively made the permission instead based on the company’s balance sheet.

As a result of these changes, the Australian Taxation Office (ATO) has released Draft Taxation Ruling, TR 2011/D8 titled ‘Section 254T of the Corporations Act and the assessment and franking of dividends paid from 28 June 2010’.

The Draft Ruling explains the following:

  • Where a company pays a dividend out of current trading profits recognised in its accounts, available for distribution in accordance with its Constitution and without breaching the Corporations Act 2001, the company will not be prevented from franking that dividend because the company has not recouped the previous year’s accounting losses or has lost part of its share capital.
  • Where a company pays a dividend out of an unrealised capital profit of a permanent character recognised in its accounts, available for distribution in accordance with its Constitution and without breaching the Corporations Act 2001, the company will be able to frank that dividend provided the company’s net assets exceed its share capital by at least the amount of the dividend.
  • A distribution paid by a company that does not comply with the Corporations Act 2001 is not a frankable dividend; it will be treated either as an unfranked dividend, or as an unauthorised reduction and return of share capital, which will be taxed as a capital gains tax event, depending on the particular facts and circumstances of the payment.

These principles provide companies with greater flexibility in the declaration and payment of dividends.  A company with an appropriate amount of net assets but not sufficient profits may now be permitted to pay a dividend.  The opposite is also true; a company who does not have sufficient net assets but does have profits may not be permitted to declare a dividend.

The principles outlined in the Draft Ruling provide companies with greater flexibility in thedeclaration and payment of dividends.  However, there are a number of issues that may impact the availability of this, as well as other impacts from the law changes that companies should consider.

The application of these principles may impose an additional accounting and administrative burden on companies that are not required to comply with Australian Accounting Standards, such as small proprietary companies.  For example, the Corporations Act 2001 requires that Australian Accounting Standards be applied in determining if a company’s assets exceed its liabilities.

Further, directorsmay need to seek professional advice in order to satisfy themselves that the payment of a dividend is fair and reasonable to the company’s shareholders as a whole and that it does not materially prejudice the company’s ability to pay its creditors.

In addition, the directorsof a company must always consider their overriding duty to ensure that the company does not trade when insolvent.

Finally, the powersof a company are contained within its Constitution so the clauses related to the ability to pay dividends must be considered.  Irrespective of the above information outlined in this article, the Constitution of the company must enable the directors to pay the dividend in the circumstances being considered.  Many standard Constitutions only provide for the payment of dividends from the profits of the company. Therefore, in order to access this additional flexibility, these companies may be required to adopt a new Constitution to reflect the changes to the Corporations Act 2001.

Examples based on the Draft Ruling are outlined below.

Example 1: Dividend paid out current year profits and there are accumulated losses
Company A has accumulated losses; however, in the current year it generates a profit.  The current year profits are not offset against the company’s accumulated losses and are not otherwise made unavailable for distribution.
Company A’s balance sheet is as follows:

Assets and Liabilities Equity
Equity Cash..............................80
Share capital...................................140
Property, plant and equipment....20
Accumulated losses..................... (70)
  Current year profit.......................... 30

Net assets ..............................100
Total equity.................................. 100

Company A determines to pay a $30 dividend to shareholders from the current year profits identified in the accounts.  As the dividend is sourced from current year profits the $30 dividend will be frankable.

Example 2: Debit to reserve

Company B has the following balance sheet:

Assets and Liabilities Equity
Cash..........................................100 Share capital.......................140
Property, plant and equipment......140 Accumulated losses............(40)
 Investment in subsidiary...............40    Asset revaluation reserve......130
Net assets..................................280 Total equity..........................280

Company B’s net assets are not less than its share capital and the payment of the $80 dividend does not change this result.  Therefore, the dividend will be frankable because it has not been sourced indirectly from the share capital account.

Example 3: Dividend paid partly out of profits and partly out of share capital

Company C has the following balance sheet:

Assets and Liabilities Equity
Cash...............................................100 Share capital..........................60
Net assets.......................................100 Retained earnings....................40
  Total equity............................100

The company proposesto pay a dividend of $50. The accounting entries are as follows:

Debit (Dr)  Retained earnings $40

Debit (Dr)  Share capital           $10

Credit (Cr) Cash                         $50

Clearly the $40 portion of the distribution debited to retained earnings would be a frankable dividend in accordance with the principles stated in the Draft Ruling.

However, the amount debited against the share capital account would not be a dividend according to these principles.  Instead, this amount would be treated as a return of share capital that would give rise to a Capital Gains Tax (CGT) event under the CGT provisions.

Example 4:  Dividend paid out of an amount other than retained earnings (such as a reserve account) and net assets are less than share capital

Company D hasthe following balance sheet:

Assets and Liabilities Equity
Cash..........................................0  Share capital.....................180
Property, plant & equipment......130    Accumulated losses...........(50)
Net assets...............................130     Total equity.........................130

The company proposes to pay a dividend of $100. The accounting entries are as follows:
Debit (Dr) Dividend reserve $100
Credit (Cr) Cash                    $100

The balance sheet of Company D post-dividend distribution will be as follows:

Assets and Liabilities Equity
Cash..........................................(100) Share capital...................180
Property, plant & equipment..........130 Accumulated losses.........(50)
  Dividend reserve..............(100)
Net assets....................................30   Total equity........................30

Assume that thedividend is permitted under the Corporations Act 2001.

The dividend reserveis not a profit reserve and the net assets of the company are less than its share capital. Therefore, the payment would not be a dividend and would be taxed as a return of capital under the CGT provisions.

Alternatively, if the payment was considered a dividend, it would be unfrankable on the basis that it was sourced indirectlyfrom the share capital account. 
 
   
 

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