Draft legislation released to improve corporate law compliance burden

In brief

An exposure draft of proposed legislative amendments designed to reduce the compliance burden for businesses has been released by the Federal Government. The amendments include long-awaited changes to the dividend payment rules, the abolition of the 100 member rule and updates to remuneration disclosure obligations. Partner Wendy Rae , Senior Associate Emin Altiparmak and Lawyer Liz Clark discuss the corporate law aspects, while Partner Martin Fry reports on the tax and franking aspects.

A dividend payments rule that finally works ... for the most part

What are the changes?

The current law, in section 254T of the Corporations Act 2001 (Cth), prohibits a company from paying 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 is fair and reasonable to the company's shareholders as a whole; and
• the payment does not materially prejudice the company's ability to pay its creditors.

Under the current test, assets and liabilities are calculated in accordance with accounting standards in force at the relevant time.

The draft Bill proposes:

• to replace the current test with a pure solvency test;
• to exempt dividend payments from the share capital reduction requirements in Chapter 2J of the Corporations Act (which require shareholder approval and other formalities to be completed before capital reductions can be effected) to the extent that they are 'equal reductions' of capital for ordinary shares, where all shareholders participate equally (disregarding differences due to fractional share entitlements, different paid up amounts, different accrued dividend entitlements or the use of a dividend reinvestment plan); and
• that when dividends are paid out of sources other than profits, disclosure must be made of details about the source of dividends paid and the company's dividend policy in the Annual Director's Report.

Some of the key issues with the current test

There has been ongoing criticism of the current test and a continuing effort to fix it. The Law Council of Australia, alone, has made six separate submissions to the Federal Government to this end. Indeed, the current test itself was introduced in June 2010 to resolve issues associated with the former test that required dividends to be paid solely out of profits. In seeking to resolve concerns with the 'profits test', new layers of complexity were introduced.

The first key criticism is that the current test is unclear as to whether a dividend paid out of share capital (as opposed to out of profits) can be an authorised reduction of share capital that does not have to satisfy the capital maintenance requirements of Part 2J of the Corporations Act. Although the Explanatory Memorandum to the 2010 amendments suggests that it intended to operate as an exception to the capital maintenance rules, the section is drafted as a prohibition on the payment of a dividend unless its three tests are met. The prevailing view is that the capital maintenance provisions apply in addition to the current dividend payments test, meaning that shareholder approval must also be sought if a dividend is to be paid out of capital.

Second, the current test creates administrative difficulties, given that a balance sheet that is in accordance with accounting standards needs to be prepared as at immediately before the dividend is declared. If a company wishes to declare a dividend outside of reporting periods, this test results in compliance burdens and uncertainties. These issues are exacerbated for small proprietary companies, given they are not normally obliged to prepare accounts in accordance with the accounting standards.

Third, the net assets test can be criticised as it may not be a true indicator of the liquidity or ongoing viability of a company, particularly in circumstances where the company's balance sheet is impacted by significant non-cash charges.

Is the new test the complete solution that we have been waiting for?

The new pure solvency test will be a very welcome change. It will address the concerns posed by the second and third criticisms above, and to a large extent the concerns posed by the first criticism above. However, it does not resolve all the uncertainties and concerns raised previously.

For example, the new test does not carve out the application of Part 2J for dividends involving capital returns on preference (or other non-ordinary) shares, or on ordinary shares on a non-equal basis. It seems that the intention is that such dividends can be paid provided that they satisfy the solvency test as well as the Part 2J requirements. However, this is not expressly stated in the draft legislation. Views have previously been expressed by Counsel¹ that dividends may only be paid out of profits unless there is an express provision allowing for the distribution of share capital as a dividend. This would suggest that dividends out of capital that do not fall within the carve out cannot be paid in the first place. While this is debatable, we think that this matter can be put beyond doubt by inserting some clarifying language in the proposed amendments. Of course, this would mean that companies seeking to pay dividends out of capital, that fall outside the carve out, would need to obtain prior shareholder approval.

As a further comment, the new test does appear to signal a materially reduced role for the capital maintenance rules in Part 2J in the context of equal reductions of capital.

Income tax and franking

While the proposed amendments will impose a pure solvency test for the payment of dividends, for income tax purposes it continues to be highly relevant to understand whether or not the dividend is sourced from the profit account. Franking credits will not be recognised in the hands of the shareholder if the dividend is sourced directly or indirectly from the share capital account. Accordingly, companies and the Australian Taxation Office will continue to focus on the source of the dividend and the new requirement for directors to disclose the source of dividends paid other than from profit is likely to be important.

The end of the 100 member rule for companies

Currently, directors of a company must hold a general meeting (paid for by the company) at the request of 100 members entitled to vote at the annual general meeting. This is known as the '100 member rule'.

Depending on the company's size, the 100 member rule can give members with less than 1 per cent of the voting shares the ability to require directors to hold a general meeting. As an ordinary resolution requires 50 per cent support from those voting, the 100 member rule can lead to meetings being held to vote on resolutions that are very unlikely to be passed.

The draft Bill proposes to abolish the 100 member rule. However, groups of 100 shareholders will continue to be able to place matters on the agenda of general meetings, through other existing means.

We believe the abolition of the 100 member rule will reduce costs for businesses, while still leaving open a channel for minority shareholders to propose resolutions by placing them on the agenda of general meetings. In addition, members with at least 5 per cent of the voting shares will still have the ability to require the directors to hold a general meeting.

We note that equivalent changes have not been proposed for meetings of members of registered managed investment schemes, which (under s252B of the Corporations Act) are subject to the same requirements as companies. If the equivalent change is not made this will result in inconsistent treatment of schemes and companies which form stapled groups.

Remuneration disclosure

The draft Bill proposes that unlisted disclosing entities will no longer be required to produce remuneration reports, which will reduce their compliance burden.

The draft Bill also proposes changes to remuneration disclosure requirements for listed entities. Listed entities will have to include in their remuneration reports a general description of their remuneration framework, to the extent that it is not included elsewhere in the annual report (and if it is included elsewhere, the information must be referenced). We expect that in practice, listed companies already include this information in their annual reports.

Further, it is a current requirement that a disclosing entity disclose the value of lapsed options held by key management personnel in a disclosing year, as well as the percentage value of their remuneration which consists of options. The draft Bill proposes removing these requirements and replacing them with an obligation to disclose the number of lapsed options and the year in which the lapsed options were granted.

Have your say

There is a five-week consultation period for comments on the draft Bill, and submissions close on 16 May 2014. If you would like to contribute any comments, please contact one of our people listed below.