It has been a long held position of the Australian Taxation Office (ATO) that in circumstances where parties separate, and where a private company which effectively is under the control of one or both parties to the relationship is Ordered to transfer ownership to another party of the relationship of property, or make payment as part of the final settlement, that such property transfer or payment would be treated as the company discharging an obligation, rather than payment of a dividend by the private company. Therefore, the recipient would be exempt from being taxed on the funds or property.
New ATO Position
In July 2014, the ATO released Taxation Ruling TR2014/5, which operates to reverse the previous position.
This means that where:
- property or funds are held in the name of a private company; and
- the property or funds are considered to be part of the parties' marital asset pool; and
- an Order is made by the Family Court for the payment of funds or transfer of property to a recipient (either by the private company or directing one of the parties to cause the payment or transfer to be made);
then the party receiving the payment or property will be assessed by the ATO for payment of personal tax as if they were receiving a dividend from the private company.
Usual approach to joint liabilities
The general approach of the Family Court is that where there are liabilities (such as sale fees and commissions for the disposal of a property), or taxation consequences (such as capital gain tax on disposal of a marital investment property), that these are to be deducted from the marital asset pool.
That is, both parties will be required to suffer the loss by way of a reduced marital asset pool being available for distribution.
In practical terms, the same will be required to be applied here, as the payment or transfer will be taking place as part of the final financial settlement.
As the funds received or property transferred will be assessed as personal income of the recipient, the actual taxation liability to be incurred will generally only be able to be ascertained on completion of the recipient's taxation return at the end of the appropriate financial year.
TR 2014/5 states that the payment of funds or transfer of property from a private company pursuant to a Family Court Order is Frankable.
Where the recipient is a shareholder, they will be able to claim the Franking Credit to offset the personal tax they are assessed to pay, and where the recipient is not a shareholder, they are considered an associate of a shareholder, and they are treated in the same way for the purposes of utilising the Franking Credit.
Obviously, where a dividend in Frankable, the private company will be assessed for the tax at the company rate on the payment of the funds or transfer of property.
This means, that consideration may be required as to whether the payment or property transfer should be franked in circumstances where other third parties have involvement in the company.
De facto couples
Although TR2014/5 is drafted in relation to a marriage breakdown (referring to the Family Law Act 1975), the ruling specifically notes that it is intended to apply to the division of assets on the breakdown of a de facto relationship also.
By way of example:
A Husband and Wife are the sole Directors and Shareholders of a private company, and the company has profits which are held as cash at bank in the latest financial year of $200,000.
The parties own residential premises worth $500,000, which are subject to a mortgage of $350,000, shares worth $50,000 and 2 motor vehicles, worth $20,000 each. The Wife has $20,000 in Superannuation Entitlements, and the Husband $80,000.
The total asset pool is therefore $200,000 + $150,000 + $50,000 + $40,000 +$100,000 = $540,000.
The Wife is to retain the house, her super, and her car; a sub-total of $190,000.
The Husband is to retain the business, the shares, his super and his car; a sub-total of $350,000.
If the pool is to be divided 50/50, the Husband is required to make payment to the Wife of $80,000 from the company's funds.
The payment of the $80,000 to the Wife by the company is considered to be a dividend, and is taxed as part of the Wife's assessable income. The tax liability incurred will depend on the Wife's other personal income for the financial year, but for the purposes of this example, we will assume the tax liability in relation to the payment is $40,000.
If no account is taken by the parties in relation to the tax liability incurred by the Wife on the payment, she will end up with overall assets of $230,000, while the Husband will retain $270,000.
Accordingly, the anticipated tax liability will need to be considered as part of the overall asset pool, meaning that the available assets and funds is now $500,000, rather than $540,000.
Operation of the TR2014/5 ruling
The TR2014/5 ruling states that it is in operation and applies both before and after its date of issue, being 30 July 2014.
However, the ruling also specifically states that it will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a taxation dispute agreed to before the date of issue. Where the ruling is less favourable than the Commissioner's previous practice in relation to such orders against a private company, the ruling will not apply in respect of any orders made before the date of issue of the ruling.
The ruling will therefore apply to any orders made requiring payment or property transfer by a private company subsequent to the date of issue, or 30 July 2014.
What it means
The outcome of the TR2014/5 ruling, broadly in circumstances where parties have involvement in a private company and part of the financial division following separation involves payment to one of the parties of funds or transfer of property, there is the potential for a significant liability to reduce the size of the marital asset pool and the overall assets available for distribution.
It means that in order to avoid incurring such a liability, parties may be restricted in how they elect to divide the available funds and assets of the marital asset pool.
It also means when parties are contemplating Orders for their property division, they will need to ensure that the Orders they are seeking appropriately deal with the anticipated liability as this will usually not be incurred by the recipient until after the end of the appropriate financial year and the submitting of their tax return.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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