Tying up loose ends: The tax office rules on tax in family law
By Jeremy Hogg, Lawyer, MST Lawyers
Following from the draft taxation ruling issued in late 2013, the Australian Taxation Office (‘ATO’) released its final taxation ruling TR2014/5 (‘the ruling’) on 30 July 2014. The ruling clarifies a number of principles relating to taxation of family law property settlements and, importantly, reverses the ATO’s previously held position that a payment from a private company pursuant to a Family Court order could, in some circumstances, avoid the deemed dividend provisions of Division 7A of the Income Tax Assessment Act 1936 (‘ITAA 1936’).
What transactions does the ruling consider?
The ruling deals with distributions (including monetary payments and transfers of property) which are made pursuant to a Family Court (including the Federal Circuit Court) order under Section 79 of the Family Law Act 1975 (‘FLA 1975’), from a private company to a shareholder (or former shareholder) or an associate (or former associate) of a shareholder of that company.
When does the ruling apply?
While the ruling only applies to Court orders made under Section 79 of the FLA 1975 (which only applies to proceedings between married (or previously married) couples), the ATO specifically notes in the ruling that the approach adopted for married couples will also apply to Court orders made under the provisions of the FLA 1975 governing de facto relationships. It would seem reasonable to presume that Binding Financial Agreements settling financial disputes of married and de facto couples would also fall under the same guidelines.
Payments or property transfers to shareholders
The ruling clarifies that a distribution made to a shareholder of a company (whether the order requiring the distribution binds the company as a party to the proceedings or a party with control of the company) will be subject to the usual dividend provisions and the distribution will be taxable to the extent it is paid out of the company’s profits.
Payments or property transfers to former shareholders, associates of shareholders and former associates of shareholders
Distributions made to former shareholders, associates of shareholders and former associates of shareholders are typically not caught by the usual dividend provisions but may be deemed dividends under the anti-avoidance provisions of Division 7A of the ITAA 1936 provided that the distribution is made from the company’s distributable surplus.
Under Division 7A, distributions to satisfy an obligation to make a payment of money, where the payment was not more than would have been required to discharge the obligation had the company and the party been dealing with each other at arm’s length, may escape the deemed dividend provisions and be effectively made without further taxation consequences. The ATO’s previous position that a Family Court order could satisfy these requirements allowed parties to family law proceedings to make payments to a non-shareholder party from company coffers without the payment being taxed in the receiver’s hands, significantly reducing the parties’ overall taxation obligations. This approach had been confirmed by numerous private taxation rulings, which provided that for the exemption to apply:
- The Family Court order must have required the payment of money (rather than a transfer of property) and for the payment to have been made in money (and not as property in substitution for money);
- The order to pay money must have bound the company as a party to the proceedings, and not simply have bound a party with control of the company to cause the payment to occur, as an order binding a party would not impose the necessary obligation on the company itself.
The position taken by the ATO in the new ruling, however, reverses the previous position that a Family Court order can satisfy the ‘arm’s length’ requirement for the Division 7A deemed dividend exception to apply, taking the view that there could be no circumstance where a private company would be obliged to make a gratuitous payment to an associate or former associate in the manner required by the Family Court orders under consideration.
Capital Gains Tax Rollover
The ruling also confirms that Capital Gains Tax rollover is available to transfers of assets that attract Capital Gains Tax made pursuant to Family Court orders.
What does this all mean for family law settlements?
Following the ruling, any distributions made by a private company to a shareholder (or former shareholder) or associate (or former associate) of that company pursuant to Family Court orders will be incapable of satisfying the deemed dividend exceptions and, provided that the distribution is made from a company’s distributable surplus, the distribution will be taxable. Subject to the usual franking rules, however, dividends will be frankable.
While the ruling will not apply retroactively to orders made prior to 30 July 2014 (to the relief to parties who had previously availed themselves of the exception), parties and their financial and legal advisors will now need to carefully assess the desirability of payments being made from family businesses in the course of family law proceedings. Prudence will be required both from parties who control businesses and those who receive distributions from them: any taxation liabilities arising from company distributions must be accounted for within the matrimonial asset pool prior to a final settlement being entered into and terms of settlement will need to assign who is to take responsibility for the liability when it occurs. With these issues taken into account during negotiations, parties will be able to avoid any unforeseen post-settlement taxation repercussions and ensure that their intended outcomes are achieved.