Australia: New tax trap for relationship breakdowns
14 October 2014
Posted by: Authors: Genevieve Morgan and Patrick Huang
Authors: Genevieve Morgan and Patrick Huang (Rockwell Olivier)
For many people, the breakdown of a spousal relationship is devastating not only emotionally, but also financially, as assets are divided and property settlements are negotiated. Even in circumstances where the split is amicable, many couples have difficulty coming to agreement on how to apportion the asset pool. Now a new ruling from the Australian Tax Office has thrown a potential spanner in the works that may make it even harder for divorcing couples to work out who gets what, and how much.
In July 2014, the ATO issued its final version of Taxation Ruling TR2014/51. This ruling clarified the position in its earlier draft ruling2 that the receipt of cash or property from a private company pursuant to Family Court orders is subject to tax as an assessable dividend.
The ruling, which appears to be a direct reversal of the ATO's previously held position, suggests that holding family assets in a corporate structure may prove to be problematic in the event of a relationship breakdown, and that the transfer of money or property from a company is best avoided in a property settlement to minimise tax implications.
It's now more important than ever that parties with an interest in a private company (especially family business owners) take this opportunity to speak to a family lawyer about protecting their personal and business interests in the event of a separation, to ensure that their business can continue to operate with minimal disruption and that their property settlement is structured in a tax effective manner and with minimal deterioration of personal and company wealth.
What are the tax implications?
Prior to the release of the new ruling, the ATO's position3 was that the payment of cash or the transfer of property from a private company to satisfy a property settlement pursuant to a Family Court order4 was not considered a payment of a dividend, on the basis that the private company was "discharging an obligation" when it made the payment or transfer.
Under the new ruling, the ATO has controversially overturned this prior treatment. The current ATO view is that where a private company is obligated pursuant to Family Court orders to pay money or transfer property to a shareholder or associate (being a party to the matrimonial proceedings), the payment of money or transfer of property is taken to be a payment of an ordinary dividend5 or a deemed dividend6 (as the case may be). Such a dividend is generally taxed in the hands of the recipient shareholder or associate at their marginal tax rates—meaning a significant amount of tax may be payable by the recipient.
The new ruling also clarified a number of ancillary tax effects that can arise from the payment or transfer in this manner, including:
- that dividends can be frankable;
- that there are cost base adjustments to the shares of the private company post-distribution for capital gains tax (CGT) purposes; and
- confirming that CGT roll-over consequences apply (for both parties) on transfer of property7.
Whilst this ruling refers to matrimonial property proceedings and Family Court orders throughout, it's equally applicable to property settlement proceedings as they apply to de facto couples and property settlements involving Binding Financial Agreements8.
How does this impact me?
The new ruling adds another layer of complexity to be considered in property settlement negotiations between former spouses. If the implications of this ruling are overlooked, an otherwise equitable property settlement can be turned into an inequitable one, particularly for the party that is in receipt of cash or property from the private company. Any extra tax that will be payable due to this new ruling will need to be crystallised to the greatest extent possible and taken into consideration as a further liability of the parties to be apportioned. How the resulting tax liabilities are to be funded will need to be specifically addressed in the Family Court orders or Binding Financial Agreement, particularly if either party proposes to transfer or receive assets that cannot be readily liquidated into cash (such as real property).
In short, the cost of divorce will rise for many couples if their property settlements are not effectively structured. The new ruling has the potential to impose large tax bills on payments that were previously treated as tax free by the ATO, thereby reducing the net assets to be divided between the parties.
What should I do?
Each family's matrimonial asset pool is unique, containing any combination of asset types, holding structures (such as trusts or companies) and associated tax attributes. The silver lining is (and always has been) that from such circumstances, tax planning opportunities can still arise—for the benefit of both parties.
When negotiating your property settlement and determining the division of the matrimonial pool of assets with your family lawyer, now more than ever it's essential that a knowledgeable tax adviser sits at the table so that your post-settlement, after-tax financial situation is canvassed in full and that any tax traps (such as this ruling) are spotted and sprung ... before you get caught.
If you're in need of advice or assistance to detangle your matrimonial assets, contact our Argyle Private team. Our family law and tax lawyers are nationally accredited and can help you navigate the often muddy waters of property settlements.
1Taxation Ruling TR 2014/5: "Income tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate)".
2Draft Taxation Ruling TR2013/D6 with the same title.
3Reportedly through ATO ID2004/462 and a significant body of private rulings prior to 30 July 2014.
4Family Court order pursuant to Section 79 of the Family Law Act 1975 ("FLA 1975").
5Under s 44 of Income Tax Assessment Act 1936 ("ITAA 1936").
6Under Division 7A of ITAA 1936.
7And not merely under section 79 of the FLA 1975, but applies to any property settlement proceedings of the kind described in subsection 126-5(1) of the Income Tax Assessment Act 1997, subject where relevant to the conditions in section 126-25 of that Act.
8Where the governing legislation is substantially similar to section 79 of the FLA 1975.
This article first appeared on mondaq.com.