The rules concerning payment of dividends have changed. Assuming the constitution of the company allows, a company may pay a dividend if the company's assets exceed its liabilities 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. Many constitutions mirror the old law, and provide that the company may only pay dividends out of profits. Companies should consider amending their constitutions to reflect this important change.
The old 'Profits Test' versus the new Three Tiered Test
Under the old legislation, section 254T of the Act applied a 'profits test' whereby dividends could "only be paid out of profits of the company". This approach was based on a capital maintenance concept where companies kept intact their initial capital base together with any subsequent capital raisings.
The new test has been introduced to enhance the flexibility in paying a dividend and reflects a shift in focus away from the old capital maintenance concept towards a more solvency based approach. The new section 254T applies to all dividends declared after 28 June 2010.
A company may no longer pay a dividend unless:
- 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.
Assets and liabilities for this purpose are to be calculated in accordance with accounting standards in force at the relevant time.
How do these changes affect your company?
Dividends can now be paid other than out of profits which may make it easier for some companies to pay a dividend. This includes companies in start up which do not have accounting profits and those with profits that have been affected by non-cash expenses. In comparison, a company that has a profit but with a deficiency in net assets will no longer be able to declare a dividend to its shareholders.
Companies should consider whether amendments to the provisions in their constitutions regarding dividends should be sought at the next annual general meeting. Many constitutions provide that the company may only pay dividends out of profits. Companies should consider amending their constitutions to:
- remove rules which restrict payments of dividends only from profits, and
- permit directors to determine the time and amount of a dividend (if the constitution does not already allow such a determination).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.