This marks the third and final instalment in our Insights | Bitcoins and blockchain series. In this section we consider some of the limitations of automating aspects of corporate distributions and family law.
From the analysis we have undertaken further below, it appears that Smart Contract failure will arise in cases where there is a lack of uniformity in contracting terms, complexity in regulatory environment and high incidences of manual intervention.
Corporate governance in the context of automated distributions
An AFR article in June 2016 described the possibility of an Ethereum-based share certificate being programmed to automatically send the owners of stock dividends should corporate profits reach a certain level.
There are significant commercial and tax considerations which must be considered at a corporate level before a dividend is declared, including:
- the decision to reinvest profits and consequential impact on investor returns;
- whether the company will comply with the Corporations Act in declaring the proposed dividend;
- compliance with directors’ duties under the Corporations Act; and
- the corporate tax entity’s available of “franking credits”.
A reinvestment strategy provides a simple but effective explanation of the limitations of automated corporate governance – in such a case, the Board of Directors (or their delegates) must be given the power to manually override an automated distribution to give effect to the reinvestment of profits.
In the lead-up to invoking the manual override power, one would expect the Board and delegates to have considered the company’s present and future circumstances and the cost-benefit analysis of distributing vs reinvesting profits. In our view, it is unlikely that existing Smart Contract / Blockchain technology would be capable of such a sophisticated decision-making process.
Corporations law and directors’ duties
Section 254T of the Corporations Act sets out the circumstances in which a dividend may be paid. It involves an enquiry into matters which may not be directly translatable into programming language, such as whether the dividend is fair and reasonable to the company’s shareholders as a whole and material prejudice to the company’s ability to pay its creditors. It may also involve consideration of the accumulated body of common law authority which must be distilled into a discrete set of programmed rules capable of execution in a Smart Contract.
Moreover, it must be appreciated that Australian corporations law and the law of directors duties (which is influenced by is not static and application of the law to each company’s circumstances will not result in uniform outcomes.
Insight: if an automated dividend solution is adopted, there is a serious question as to how the Board of Directors and management team are educated and kept appraised of the mechanics and parameters of the automated process particularly in periods of commercial and legislative uncertainty.
Franking credits and unintended tax consequences
A corporate tax entity’s franking credit strategy must accommodate its previous franking percentages and future anticipated franked distributions.
By way of example, if a corporate tax entity over-franks a distribution, it will be liable to pay over-franking tax. In this regard:
- the over-franking tax is equal to the amount of franking credits allocated in excess of the benchmark; and
- this tax, when paid, does not generate a credit in the corporate tax entity’s franking account.
Insight: the liability to pay the over-franking tax without generating a corresponding credit in the entity’s franking account is a permanent and adverse 30% income tax expense.
The commercial, legal and tax framework within which dividend policy is established, maintained and adapted is not readily capable of translation into a functional automated process given present technological constraints and limitations.
Having said this, there may be aspects of corporate governance with respect to dividend distributions which would be benefit from automation, including payment and administrative disclosure / record-keeping functions.