Under the new section 254T of the Corporations Act, a company must not pay a dividend unless:
- Its assets exceed its liabilities immediately before the dividend declaration and the excess is sufficient for the dividend payment, and
- The dividend is fair and reasonable to all classes of members, and
- Creditors are not materially prejudiced.
Dividends can be distributed as franked dividends or unfranked dividends. Franked dividends have an imputation credit attached to them. This credit is the tax paid by the company distributing the dividend. Resident shareholders are assessed on the total amount of the dividend and the imputation credit, but are entitled to an imputation offset equal to that credit. A dividend can be franked if:
i. It is paid out of “profits”
ii. It is paid in accordance with the company’s Constitution
iii. It does not breach section 254T of the Corporations Law (which means the company must be solvent and have positive net assets see paragraph 2 above)
The franking account of a company also needs to be considered when deciding whether to pay franked or unfranked dividends. The franking account is used to keep track of the amount of franking credits a company has at any particular time. The account records the amount of franking debits and franking credits that are attributable to the company. This enables a company to ascertain the franking account balance at any time, particularly when paying dividends. Franking accounts are kept on an annual basis. They do not form part of the company’s financial statements. Franking credits most commonly arise when a company makes a payment of tax or receives a franked dividend. A debit commonly arises when a company pays a franked dividend.