Deciding Whether Your Private Company Should Pay Dividends? Here's What You Need to Know

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Of the four primary business structures utilised in Australia, many operate as private companies. If you're the owner of a profitable private company, you will inevitably be faced with the choice of whether to pay dividends or not. 

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There is much to consider before paying dividends — in this article, we recap some of the key points to paying dividends from private companies to help you make an informed decision. 

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Dividends explained 

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Profit on your bottom line is a desirable business outcome. Also known as your 'distributable surplus or retained earnings', what you do with your company's profit is up to you. One option is to retain the money, effectively reinvesting the funds back into your business, and another is to distribute the profits to your shareholders as a return for their investment in your company!

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Types of dividends

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The frequency of dividend payments is typically the characteristic that will categorise them into one of three main dividend types:

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Special dividends

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Aptly named, special dividends are dividends paid on special occasions. Such occasions may include a sharp profit increase over a particular period. 

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Interim dividends

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Interim dividends are typically paid halfway through the financial year or quarterly. 

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Final dividends 

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Following a company's Annual General Meeting (AGM) at the fiscal year's end, 'final dividends' are generally paid, as it's when the company's financial success is made known. It’s important to note that there is no legal requirement for private companies to hold an AGM, and in many cases would not make sense if there is only an individual shareholder. 

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Why pay dividends? 

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As we mentioned above, a dividend ultimately rewards your shareholders for their investment in your company. If you and perhaps your spouse are the only shareholders, dividends can be used as a way to distribute the profit so you can personally use it, rather than retaining it in the company for business purposes. 

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The upside to paying dividends is that when your company pays regular dividends of a stable value over time, existing shareholders, owners and potential investors typically view your company to be in good financial health, and regard the quality of the company management highly. For private companies, this may not always be important, but it’s worth thinking about if there’s a chance you’re looking at options to raise capital in the future. 

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How to pay dividends 

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Firstly, it's up to the company's directors whether to pay shareholders a dividend. For many private companies, the directors are the shareholders, however, if a company grows and external shareholders buy into the company, it's not up to the other shareholders whether a dividend is paid or not; the responsibility remains solely with the company directors. 

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Dividends are paid based on each share of the company's stock. The two most common ways that dividends are paid out are:

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1. Cash dividends, which are paid directly to an investor's nominated bank account. 

2. Through the allocation of additional stock in your company (known as stock dividends). 

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Considerations for company directors before paying dividends

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Before paying dividends, company directors need to ensure that there are sufficient net profits to pay dividends, as well as cover any additional requirements under the company's constitution and shareholder agreement. 

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Ensuring that your company has sufficient net profit to dividends isn't just prudent business management but a general law principle. 

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ASIC requirements 

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In addition to the above, ASIC also applies a secondary set of tests to run your company's situation through to ensure that a dividend can be paid. These include:

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• Your company must be solvent at the time of the dividend payment, meaning that the company's assets must exceed its liabilities (by at least the amount of the declared dividend). 
• The dividend payment must not prejudice your company's ability to pay creditors. A director's duty means that they must ensure profits aren't taken by company owners unless there is certainty that all the company's obligations can be met, including ATO obligations, staff wages, and any payments to creditors and financial institutions. 
• The dividend that's paid must be both reasonable and fair for all shareholders (this is pertinent if your company has different classes of shareholders). 

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Retained earnings balance 

It's important to consider whether the company has sufficient net profit to pay dividends and whether the resultant financial statements reflect a positive earnings balance for the company. 

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Will you offer franked or unfranked dividends? 

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Provided that your company hasn't breached the franking benchmark rule set by the ATO, you can choose whether to pay a shareholder an unfranked dividend or a franked dividend. 

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Franking effectively allows a shareholder to receive credits for the tax that's already been paid on the dividend at the company tax rate; therefore, a fully franked dividend is a dividend that has been fully taxed at the company tax rate, and an unfranked dividend hasn't been taxed as company income. 

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You may also have the option to pay partially franked dividends, where the dividend is only partially taxed at the company take rate, meaning that shareholders would receive a franking credit for the already-taxed portion of the dividend (the remainder to be paid at their individual tax rate). 

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It’s a good idea to consult an accountant when deciding whether to pay franked vs unfranked dividends to ensure the most effective tax treatment for all stakeholders. 

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Notifying your shareholders 

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Once the decision to pay dividends has been made, the shareholders must be notified — this is known as a dividend or distribution statement. 

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Talk to your business adviser and accounting professional before paying dividends 

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If you're a private company owner in Australia, your business adviser, other company directors and your company accountant will all play a crucial role in helping with the process of dividend payment. From understanding your solvency position, knowing what type of dividend to pay, your tax implications, reporting and documentation, Bonerath & Co. can assist. 

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