Australia: Certain divorce settlements more costly under new ATO ruling

Last Updated: 12 August 2014
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Joining me today is Alison Ross, who is a Partner in the Family Law Team and Justin Byrne who is a Special Counsel in the Tax Practice both at HopgoodGanim. Alison, Justin thanks for joining me.

Thanks Kate.

Thanks Kate.

Now we're talking about a new ruling from the ATO that could make getting divorced more expensive for wealthy couples, Justin what does the new ruling look to do?

Well broadly the ruling makes it far more difficult for spouses to access cash and other property in the company that is part of their group and is controlled by them, and the difficulty applies to all spouses no matter whether their companies have $1000 worth of assets or hundred million dollars' worth of assets in them. So the ruling doesn't simply effect wealthy spouses it affects all spouses who have utilised a company as part of their group structure, and now wish to divide up the property in that company as part of their property settlement. Previously it was possible, for example, for the company to pay an amount to one of the spouses and that payment not be subject to tax. The Commissioner gave a number of private rulings on the issue confirming this, but now after all this time the Commissioner in the ruling is now taking the opposite view, which the Commissioner acknowledges in the ruling. The effect of the ruling is essentially that in a number of scenarios where previously no tax would be payable, tax is now going to be payable. Depending on the marginal tax rate of the spouse involved, tax of up to 49% could now be paid, and this means that effectively half of the payment will be lost in tax.

And Justin how will the ruling impact on divorcing couples?

Well there would appear to be two broad outcomes; firstly the parties may longer – sorry may no longer proceed at all with a proposed transfer of cash out of their company as part of the property settlement. On the basis to do so would likely result in a tax liability. They will instead seek an alternative way of dividing up the assets between them, it may be the case for example that the cash in the company simply remain as is. The second outcome is that if the parties have no other choice but to transfer cash out of their company, the tax liability will need to be taken into consideration as part of the property settlement, so in essence after the tax is paid less will be available to share between the parties.

Kate there has been a lot of consideration and commentaries about these issues, given that there are currently CTG roll over concessions for divorcing spouses as well as stamp duty exemptions on property settlements, the Commissioner's ruling might appear to be out of step with some of those exemptions. Some commentators have even suggested that the views expressed by the Commissioner are simply incorrect. Other commentators have pointed out though that the ruling simply levels the playing field as before it was enacted payments could be made to divorcing couples essentially tax free, but this isn't something that was available to other company owners. Whatever the view is taken of the Commissioner's new ruling and approach, there will certainly now need to be greater scrutiny of the tax implications of a property settlement if it involves dealing with assets of a company, and as Justin has indicated if a payment is required out of a company it will likely result in tax payable which in turn will reduce the pool available for division between the parties.

So Alison, what are the considerations then that divorcing couples will need to make during any negotiations?

As has long been the case a good understanding of the tax ramifications of any property settlement by both parties is key to ensuring that not only are the parties properly taking into consideration the quantum of the tax liabilities, but also that the after tax split between the parties is as was intended in their negotiations. Neither party benefits from any more tax being paid than is necessary, but similarly neither party will wish to receive an unforeseen tax bill after the property settlement is finalised. For family lawyers it will be very important to ensure that their clients receive specialist advice either from an experienced tax lawyers or an accountant in the area, particularly as the treatment of the payment will depend upon whether it is paid out of profits or not. If it isn't paid out of profits the question of whether it is a dividend won't arise. This is something that family lawyers may not be able to readily identify and where they and their clients will require some financial and tax advice.

And if there really is no choice but for the parties to divide up their cash in their company, a consideration of the franking account of the company may then be warranted. If a payment made to a spouse or other party from the company is a dividend or deemed dividend in accordance with the ruling, it's possible for the dividend to be franked, provide the company has sufficient franking credits. While this doesn't stop the dividend being taxable upon receipt, it does however provide a credit of 30% tax representing the tax already paid by the company. The recipient of the dividend would generally then have to pay a top up tax amount which is the difference between 30% already paid by the company and the recipient's marginal tax rate which now may be up to 49%.

And Justin just finally, I guess are there any steps that couples can take if they're looking to avoid the additional tax?

Look I think there are, I think generally there will be alternatives to avoiding the payment from the party's company being a dividend or deemed dividend. For example it may be possible to simply provide the spouse with another asset rather than cash from the company or a debt facility might be obtained using the company's assets of security, enabling a payment to be made to the spouse from a non-company entity, for example an individual or a trust. Also still a restructure of the company may enable the spouse to ultimately receive shares in the company which in turn owns the cash, the CTG roll over provisions may also be utilised in such instance such that any capital gains tax is deferred. Now with any such restructure or planned course of action, the general anti-avoidance rules will also need to be considered, and a restructure will generally fall foul of those provisions if on an objective basis a tax payer enters into the arrangement for the sole or dominant purpose of obtaining a tax benefit such is the deferral or avoidance of tax. So as in all cases concerning the tax treatment of property settlements it is strongly recommended that parties obtain specialist advice from experienced practitioners in the area.

Yes certainly, a number of considerations for people to take into account there, and I think getting proper advice makes sense. Alison and Justin thanks so much for talking with me today.

Thanks Kate.

Thanks Kate.

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