The dividend dilemma02 November 2017
Since the introduction of the new balance sheet test for the payment of dividends in 2010, there has been considerable debate on the correct interpretation of s 254T of the Corporations Act 2001 (Cth) (Corporations Act). The Courts, Parliament and even the Australian Taxation Office have varied between narrow and broad interpretations, and while clarity is yet to be obtained, there is at least more certainty provided by rulings, which companies need to be aware of to ensure they are compliant with the law when making dividend payments.
History of s 254T
Under what is now the "old" s 254T of the Corporations Act, dividends could only be paid out of the profits of a company. However, in 2010 this section was replaced with a new balance sheet test for the payment of dividends. The amended (and current) s 254T provides that a company must not pay a dividend unless:
- its 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 shareholders as a whole, and
- the payment of the dividend does not materially prejudice the company's ability to pay its creditors.
The amended section was initially understood to permit a company to pay dividends out of profits and capital. If a company paid a dividend out of capital, complying with s 254T, it would not be required to obtain shareholder approval (or to comply with the capital reduction provisions in chapter 2J of the Corporations Act). Essentially, it operated as an exception, which was certainly the intention of the drafters?the Treasury also agreed the legislation was clear on this point. This view represents the broader interpretation of s 254T.
However, many believe the drafters' intentions miscarried, mainly because of the negative drafting of s 254T. On this view, s 254T merely prohibits the payments of dividends in certain circumstances, as opposed to authorising any act by the company. It follows that a company could not pay a dividend out of capital under s 254T unless it complied with the specific requirements (including shareholder approval) under chapter 2J. This view represents the narrower interpretation of s 254T.
The debate has not been resolved by legislation. In 2014, the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 (Cth) (the Bill) was introduced. Among other things, the Bill was intended to make it clear that a company could pay dividends out of capital without complying with chapter 2J. The only requirement was that reductions in capital from the dividend must amount to an "equal reduction"-that is, the dividend must only be paid to holders of ordinary shares on an equal and pro rata basis. However, these proposed amendments were abandoned as Parliament needed more time for further consideration.
The debate has not been settled by the Courts either, but there has been some judicial support for the broader interpretation.
In Grant-Taylor v Babcock & Brown Ltd (In Liquidation)  FCA 149, the Federal Court held that Babcock & Brown had contravened the old s 254T profits test by paying dividends out of capital in 2005, 2006 and 2007. The Court (in obiter) noted that, "As a result of the changes (which were made in 2010) it is now lawful to pay dividends out of capital so long as the payment does not affect the solvency of the company paying the dividend".
On appeal, the Full Court of the Federal Court agreed with the finding and (also in obiter) said, "As we have said, in 2010, s 254T was substantially changed in the manner set out earlier. It is not in dispute that under the current law the declaration and payment of dividends by BBL would have been lawful".
Although the statements by the Court in both cases are not binding, they clearly support the broader interpretation of s 254T and go some way to resolve the debate?it may be some time though before this is conclusively determined.
As a consequence of the 2010 amendments to s 254T, taxation law was also amended to ensure company distributions that were paid as dividends in reliance on the new s 254T (not paid out of profits) would be included in a shareholder's assessable income as dividends. This would be achieved by deeming such dividends to be paid out of profits for taxation purposes. However, this was always subject to the exclusion of amounts debited against an amount standing to the credit of a company's share capital account. Such amounts will not be dividends for taxation law purposes.
In June 2012, the Australian Taxation Office released Taxation Ruling 2012/15 (TR 2012/15), which aimed to clarify a number of issues surrounding the assessment and franking of dividends. TR2012/15 adopted the narrower interpretation of s 254T-namely, that it does not authorise a return of capital but merely prohibits the payments of dividends in certain circumstances. Irrespective of whether the narrower interpretation is the correct interpretation or not, a distribution characterised as a dividend for the purposes of s 254T will be treated as follows under taxation law:
- A distribution out of the profits of the company will be an assessable dividend for taxation purposes, even if the company has accumulated losses in earlier years or has lost part of its share capital. That dividend will be frankable under the imputation provisions of taxation law.
- A distribution out of unrealised capital gains of a permanent nature will be assessable as a dividend for taxation purposes. However, the dividend will only be frankable if the company's net assets exceed its share capital by at least the amount of the dividend. Otherwise, the dividend may not be frankable under the imputation provisions of taxation law.
- A distribution that is debited against an amount standing to the credit of the company's share capital account will not be a dividend for taxation purposes, but will be taxed as a capital gains tax (CGT) event under the CGT provisions of taxation law.
This is not the (divid)end
While the debate continues, companies should remain astute regarding the potential changes to s 254T to ensure they are compliant with any dividend payments and consult professional legal advice where there is any ambiguity, before making any payments.