Effective from 28 June 2010 your company may pay dividends other than out of company profits provided certain requirements are met. These changes may permit, for example a start-up company or a company impacted by non-cash expenses, to pay a dividend.
We summarise here the old rules, changes to new rules and practical considerations that your company may need to take action to comply with these new changes.
Out with the old
Prior to the rule change, a dividend could only be paid out of the ‘profits’ of the company. That means this rule prevented a company who had surplus cash funds from paying surplus cash to members as a dividend, to the extent its profit position had been impacted by no-cash write downs.
In with the New
Under the new rules the profits test has been removed and it has been replaced by a three tiered test. All elements of the three tiered test must be satisfied before a dividend may be paid.
Net assets test- the company’s assets must exceed its liabilities immediately before the dividend is declared by at least the amount of the dividend; and
Creditor test – the payment of the dividend must not materially prejudice the company’s ability to pay its creditors.
These new tests reflect timing differences at the time of both declaration and payment of the dividend. That is, your company must satisfy the net assets test at the time a dividend is declared and the creditors test at the time of payment.
The fairness test could result in some dividends that were previously paid to different class shareholders to challenge this fairness test.
Therefore, we outline a few practical considerations that your company will need to consider before paying that dividend.
- Check your company’s constitution – some constitutions may expressly limit the payment of dividend, as per the old law, to only be made out of profits of the company. If this is the case, the company will either need to amend its constitution to remove this requirement or comply with the profits test and the new three tiered tests.
- Consider what dividend payments your company may wish to declare or pay in the future.
- Before determining that a dividend is payable, the directors should undertake a review and document in form of directors minutes of meeting, making sure that the constitution is in line with payment of dividends and that each of the three tests above have been satisfied.