House of Representatives

Explanatory Memorandum

Circulated By the Authority of the Minister for Financial Services, Superannuation, Corporate Law and Human Services, the Hon Chris Bowen

Chapter 1 - Companies limited by guarantee

Context of amendments

1.1 Under the existing reporting framework, all companies limited by guarantee are required to prepare an audited financial report in accordance with the Australian accounting standards and a directors' report in accordance with the Corporations Act 2001 ( Corporations Act), regardless of their size.

1.2 The company limited by guarantee structure is used predominantly by not-for-profit entities to incorporate their operations. Research conducted by The University of Melbourne found that approximately 21 per cent of companies limited by guarantee were sports and recreation related organisations, 19 per cent were community service organisations, 15 per cent were education-related institutions and 10 per cent were religious organisations.

1.3 The vast majority of companies limited by guarantee are relatively small. The table below outlines the relative size of companies limited by guarantee based on a sample of companies that lodged financial reports with Australian Securities and Investments Commission (ASIC). The small size of companies limited by guarantee means that they may not have the capacity to comply with extensive reporting requirements. However, as discussed below, it is recognised that reporting by companies limited by guarantee is an important governance and transparency mechanism given the public nature of these companies.

Table 1.1 : Size of companies limited by guarantee ^[1]

1.5 In June 2007, Treasury released a discussion paper on financial reporting by unlisted public companies. The paper sought comments on whether the existing reporting framework was appropriate for the 11,000 companies limited by guarantee and the 7,000 unlisted public companies limited by shares preparing financial reports under the Corporations Act.

1.6 The majority of respondents to the discussion paper indicated that for reporting purposes, companies limited by guarantee could be differentiated on the basis of the size of their operating revenue. Tests based on assets or number of employees may not be accurate indicators of the 'size' of the company. For example, a company limited by guarantee may have a large number of assets, but there may be restrictions on the company disposing of these assets. In addition, indicators based on employee numbers are likely to be distorted by the large number of volunteers that generally participate in not-for-profit entities.

1.7 The submissions also noted that some types of companies limited by guarantee will have a higher level of public interest due to the nature of their activities. Charities, for instance, were identified as being in this category because of their public fundraising activities (for example, donation drives) and significant community involvement. In contrast, member-focused companies limited by guarantee (for example, sporting clubs) may have a significantly lower level of public interest. Such factors need to be considered when differentiating between companies limited by guarantee for reporting purposes.

1.8 Any differentiation between companies limited by guarantee on the basis of the nature of their activities needs to be sufficiently clear to ensure that companies are certain of their reporting obligations. For this reason, it is proposed that classification as a deductible gift recipient for the purposes of the Income Tax Assessment Act 1997 be used to differentiate between companies limited by guarantee in terms of the nature of their activities. Deductible gift recipients may receive tax deductible donations from the public. As such, it is considered to be indicative of a high degree of public interest in the activities of the company.

Summary of new law

1.9 A three tiered differential reporting framework will be introduced exempting small companies limited by guarantee from reporting and auditing requirements and providing other companies limited by guarantee with streamlined assurance requirements and simplified disclosures in the directors' report. In addition, the process for companies to distribute the annual report to their members will be streamlined.

1.10 Companies limited by guarantee will be prohibited from paying a dividend, as the corporate structure of companies limited by guarantee means that they are not suited for conducting for-profit activities which could legitimately warrant the payment of dividends to members. This prohibition applies only to companies limited by guarantee incorporated on or after commencement of these provisions.

1.11 This proposal is aimed at introducing a tailored financial reporting regime for companies limited by guarantee that will reduce the regulatory burden on these entities while ensuring that appropriate levels of financial transparency and governance are maintained.

Comparison of key features of new law and current law

Detailed explanation of new law

Differential reporting framework

1.12 Under the proposed new law, a three tiered differential reporting framework would be introduced for companies limited by guarantee.

1.13 Under the first tier, companies would be exempt from preparing the financial report and the directors' report. As a result, companies in this tier would not be required to have the annual report audited, or be required to appoint an auditor. This tier comprises of companies limited by guarantee with annual revenue less than $250,000 which do not have deductible gift recipient status.

1.14 Under the second tier, companies would:

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prepare a financial report, which they could elect to have reviewed rather than audited;

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prepare a streamlined directors' report, rather than a full director's report; and

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be subject to a streamlined process for distributing the annual report to members.

The second tier comprises of the following companies limited by guarantee:

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companies with an annual revenue of less than $250,000 that are a deductible gift recipient; and

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companies with an annual revenue of $250,000 or more but less than $1 million, irrespective of whether the company is a deductible gift recipient.

1.15 Under the third tier, companies would:

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continue to prepare an audited financial report;

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prepare a streamlined directors' report, rather than a full director's report; and

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be subject to a streamlined process for distributing the annual report to members.

The third tier comprises of companies limited by guarantee with an annual revenue of $1 million or more, irrespective of whether the company is a deductible gift recipient.

1.16 The Bill provides a regulation making power to vary the amount of the threshold, to ensure that the threshold can be easily updated over time. In addition, the Bill provides that the revenue and consolidated revenue are to be calculated in accordance with accounting standards.

[Schedule 1, Part 1, item 14, section 285A]

Exception where direction by ASIC or members

1.17 Appropriate safeguards would be put in place requiring companies limited by guarantee to prepare a financial report or a directors' report if they are directed to by ASIC or by at least five per cent of members [Schedule 1, Part 1, item 16, sections 294A and 294B]. The requirements relating to a direction from ASIC or at least five per cent of members are similar to the existing requirements applying to small proprietary companies in sections 293 and 294 of the Corporations Act.

1.18 The Bill provides a strict liability offence where a company fails to comply with a direction given by ASIC [Schedule 1, Part 1, item 16, subsection 294B(2)]. This will facilitate effective enforcement and compliance of this requirement.

1.19 A direction by ASIC under subsection 294B(1) is not a legislative instrument within the meaning of section 5 of the Legislative Instruments Act 2003 [Schedule 1, Part 1, item 16, subsection 294B(6)].

Exception for Commonwealth companies or subsidiaries of Commonwealth companies and Commonwealth authorities

1.20 The following entities are excluded from the proposed reforms applying to companies limited by guarantee:

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a Commonwealth company;

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a subsidiary of a Commonwealth company; or

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a subsidiary of a Commonwealth authority.

[Schedule 1, Part 1, items 4 and 30, paragraphs 45B(d) and 301(3)(a)]

1.21 The directors of a Commonwealth company (a company subject to the Corporations Act that the Commonwealth controls, whether they are companies limited by shares or companies limited by guarantee) are required to comply with the annual reporting requirements in the Commonwealth Authorities and Companies Act 1997 ( CAC Act).

1.22 The annual reporting requirements in the CAC Act currently require the directors of a Commonwealth company to provide to their responsible Minister the company's financial report, directors' report and auditor's report required by the Corporations Act for a financial year, as if the company were a public company under the Corporations Act.

1.23 The CAC Act also requires the directors of Commonwealth authorities and companies to ensure that certain information regarding subsidiaries is included in their reports and that the financial statements of those subsidiaries are audited by the Auditor-General.

1.24 By excluding Commonwealth companies and subsidiaries of Commonwealth companies and Commonwealth authorities from the coverage of these reforms, such entities will continue to maintain the higher level of reporting that is appropriate given that the entity is controlled by the Commonwealth, and their reports are tabled in Parliament.

Exception for certain bodies corporate

1.25 The following entities are excluded from the proposed reforms applying to companies limited by guarantee:

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a transferring financial institution of a State or Territory; or

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a company that is permitted to use the expression 'building society', 'credit society' or 'credit union' under section 66 of the Banking Act 1959.

[Schedule 1, Part 1, items 4 and 30, paragraphs 45B(d) and 301(3)(a)]

1.26 These entities are currently subject to a tailored financial reporting regime under Part 12.6 of the Corporations Regulations 2001, and as such, the proposed reforms will not apply to such entities.

Audits and reviews

1.27 The current framework requires companies limited by guarantee to have their financial reports audited by a registered company auditor in accordance with Australian auditing standards. Stakeholders have suggested that many small companies limited by guarantee are currently spending a disproportionate amount on audit fees. This reduces the resources that the company has available for member services.

1.28 Under the new law, companies falling within the second tier would be given the option of having their annual report subject to a review, rather than an audit . [Schedule 1, Part 1, item 30, subsection 301(3)]

1.29 A review, in contrast to an audit, is not designed to obtain reasonable assurance that the financial information reported by the company is free from material misstatement. A review consists of making enquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review may bring significant matters affecting the financial information to the assurance practitioner's attention, but it does not provide all of the evidence that would be required in an audit.

1.30 This measure is intended to reduce the time and costs associated with having the financial statements audited, whilst ensuring that the financial information is still subject to an appropriate degree of assurance.

1.31 The review would be conducted in accordance with a standard on review engagements developed (and modified as appropriate) by the Auditing and Assurance Standards Board (AUASB).

1.32 The review could be undertaken by either a registered company auditor, or a member of a professional accounting body that holds a prescribed practising certificate . [Schedule 1, Part 1, item 45, section 324BE]

1.33 The associated regulations prescribe the following practising certificates:

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the Certificate of Public Practice issued by the Institute of Chartered Accountants in Australia (ICAA);

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the Public Practice Certificate issued by CPA Australia Ltd or the National Institute of Accountants (NIA).

1.34 This measure will expand the category of individuals that are permitted to undertake a review, which will provide greater flexibility and reduce unnecessary burden on companies limited by guarantee and their auditors, particularly during peak periods.

Streamlined directors' report

1.35 Currently, all companies limited by guarantee are required to prepare a directors' report. The existing directors' report disclosure requirements for companies include a large number of provisions that are not relevant for not-for-profit companies. These include disclosures relating to the payment of dividends and options issued to directors as remuneration. In addition, not-for-profit companies are generally purpose or objective driven. As such, stakeholders in not-for-profit companies are likely to be particularly interested in the objectives of the organisation and how the activities conducted during the period contributed to achieving those objectives.

1.36 Under the new law, companies falling within the second and third tiers would be exempt from complying with the existing directors' report disclosure requirements, and would instead prepare a simplified directors' report . [Schedule 1, Part 1, item 14, section 285A]

1.37 The simplified directors' report would contain the following disclosures:

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a description of the short and long term objectives of the entity;

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the entity's strategy for achieving those objectives;

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the entity's principal activities during the year;

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how those activities assisted in achieving the entity's objectives; and

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how the entity measures its performance, including any key performance indicators used by the entity.

[Schedule 1, Part 1, item 29, subsections 300B(1) and (2)]

1.38 In addition, the simplified directors report would contain details of:

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the name of each person who has been a director of the company at any time during or since the end of the year and the period for which the person was a director;

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each director's qualifications, experience and special responsibilities;

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the number of meetings of the board of directors held during the year and each director's attendance at those meetings;

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for each class of membership in the company, the amount which a member of that class is liable to contribute if the company is wound up; and

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the total amount that members of the company are liable to contribute if the company is wound up.

[Schedule 1, Part 1, item 29, subsection 300B(3)]

1.39 By creating a set of tailored, non-financial disclosure requirements for companies limited by guarantee that recognises the not-for-profit nature of these entities, the measure will result in more relevant information being provided to stakeholders. In addition, it will reduce the range of reporting requirements currently imposed on companies limited by guarantee.

Distribution of annual reports

1.40 The Corporations Act currently allows companies limited by guarantee to distribute their annual reports to members via the Internet. However, small companies limited by guarantee may not have sufficient resources to maintain a website. In these circumstances, companies are required to send members a hard copy of the annual report. This can be a considerable burden if the company limited by guarantee has a large number of members.

1.41 Under the new law, members wishing to obtain a hard copy or an electronic copy of the company's latest annual report can elect to obtain this from the company free of charge, and the company limited by guarantee must comply with this request. This will minimise the regulatory burden on companies limited by guarantee by ensuring that they do not need to write to members each year informing them that the report has been prepared . [Schedule 1, Part 1, item 40, section 316A]

1.42 An election made by members to either receive a hard copy or an electronic copy is a standing election for subsequent financial years until the member changes the election [Schedule 1, Part 1, item 40, subsection 316A(3)]. This will ensure that members do not need to repeat their requests for a copy of the report each year.

1.43 The Bill provides a strict liability offence where a company fails to send a member a copy of the report in accordance with subsections 316A(3) and (4) [Schedule 1, Part 1, item 40, subsection 316A(5)]. This will facilitate effective enforcement and compliance of this requirement, and will safeguard member's rights to access financial information relating to the company.

Payment of dividends

1.44 Currently, the Corporations Act does not prohibit companies limited by guarantee from paying dividends. Despite this, the corporate structure of companies limited by guarantee means that they are not suited for conducting for-profit activities which could legitimately warrant the payment of dividends to members. Some companies limited by guarantee have already remedied this situation by providing in their constitution a prohibition on the payment of dividends.

1.45 In order to address this situation for all companies limited by guarantee, the new law prohibits companies limited by guarantee, incorporated on or after the commencement this provision, from paying dividends to members . [Schedule 1, Part 1, item 6, section 254SA]

1.46 This prohibition does not apply to entities that have been exempt from this reform, such as transferring financial institutions, building societies, credit societies or credit unions.