Dividend payments - key issues for Australian company directors

Dividends are a common way for companies to distribute value to shareholders, but whether to declare or pay a dividend is not simply a commercial decision. Directors must ensure that any dividend complies with the Corporations Act 2001 (Cth) (Corporations Act), the company’s constitution and relevant governance requirements, while considering their duties to the company and its creditors. This article outlines the key issues directors should consider before resolving to pay a dividend.

Statutory framework

A company may only pay dividends in accordance with its constitution. If a company does not have a constitution, the replaceable rules under the Corporations Act govern the distribution of dividends. Additionally, directors should look to a company’s dividend policy for any directives as to payment of dividends.

Before paying a dividend, directors must be satisfied that the company meets the three requirements in section 254T of the Corporations Act. In practical terms, this means directors should address the following questions:

Directors should consider other applicable regulatory requirements, such as prudential rules which may apply and govern dividends or capital reductions, as these continue to apply alongside section 254T.

Common law ‘profits’ test

Before the Corporations Amendment (Corporate Reporting Reform) Act 2010 (Cth) (Amending Act) came into effect, section 254T required that a company could only declare and pay dividends out of its profits. The Amending Act revised section 254T, replacing the 'profits test' with a new statutory test, as described above. As a result, while the concept of profits remains relevant for taxation and franking purposes, it is no longer explicitly the statutory basis for determining the legality of dividend payments under the Corporations Act.

Despite this legislative change, there is ongoing debate about whether the “common law profits principle” still applies with some arguing that a common law requirement to consider profits still exists. For instance, in Wambo Coal Pty Ltd v Sumiseki Materials Co [2014] NSWCA 326, the Court accepted that section 254T does not maintain the statutory rule that dividends must only be paid from profits but left open the possibility that there remains a general law principle that dividends may only be paid out of profits. Other legislation, such as section 44 of the Income Tax Assessment Act 1936 (Cth), also references dividends being paid from profits.

In light of divided opinion, a prudent approach for directors would be to pay dividends out of profits only. 

Determining vs declaring a dividend - when is a debt by the company created?

The distinction between determining and declaring to pay dividends is important as it affects when a company incurs a debt to the shareholders.

Under section 254V(1) of the Corporations Act, a company does not incur a debt merely by fixing the amount or time for payment of a dividend. The debt arises in these circumstances only when the payment date arrives, and the decision may be revoked before then. However, if the company’s constitution provides for the declaration of dividends, section 254V(2) provides that the company incurs a debt when the dividend is declared.

Board resolutions should use precise language to make clear whether the dividend is being declared or merely determined. As the High Court emphasised in Bluebottle UK Ltd v Deputy Commissioner of Taxation 232 CLR 598, the wording of the resolution determines its legal effect.

If the board wishes to preserve flexibility, it should avoid language suggesting a dividend has been declared unless that is the intention. This is particularly important when payment is scheduled for a later date or depends on cash flow/solvency considerations.

Directors’ duties – an important consideration

Directors must comply with their statutory and fiduciary duties when authorising dividend payments, including acting in good faith and in the company’s best interests under section 180 of the Corporations Act. This requires exercising care and diligence to ensure the company can meet its liabilities before declaring or paying a dividend.

Directors must ensure dividend payments do not render the company insolvent, as this could expose them to personal liability for insolvent trading under section 588G of the Corporations Act.

Paying dividends within corporate groups

In corporate groups, upstream dividend payments involve transferring funds from subsidiaries to parent companies. These dividends are often resolved back-to-back, with the parent company’s declaration of a dividend contingent on receiving funds from the subsidiary. Each company must independently satisfy the solvency test under section 254T of the Corporations Act, as a subsidiary cannot rely solely on the group’s consolidated financial position, even if the group is solvent or profitable.

Although directors of a wholly-owned subsidiary may act in the holding company’s best interests under section 187 (including if this is expressly authorised by its constitution), this does not override the subsidiary’s duty to remain solvent and comply with statutory dividend requirements.

Key takeaways

• In Australia, the Corporations Act sets out the rules for payment of dividends. If the company is a certain type of entity, other rules may apply as well, such as the prudential rules.

• In considering the rules, regard must be had to the assets / liabilities test, fairness to shareholders and ensuring there is no material prejudice to creditors.

• Directors should have regard to the terms of the company’s constitution and any applicable dividend policy.

• Directors should document their dividend decisions through resolutions / minutes and consider solvency and cashflow.

• It may still be prudent for the payment of the dividend to be made from profit.

• Getting the process and documents right are a crucial part of good governance and protects directors if a decision to pay a dividend is ever called into question.

Author: Isabella Costa

Supporting partner: Rebecca Hegarty

This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.