Tax on Divorce
Don’t forget to consider the tax implications when negotiating a property settlement as part of your divorce!
The ATO has recently advised its position on the outcome of a key element of many divorce settlements involving private companies resulting in an often unexpected, and certainly unwanted, tax on divorce!
The position is detailed in the final version of Taxation Ruling TR 2014/5 which can be accessed here.
Tax on Divorce Settlement as if just an Ordinary Payment
In short, any payment or transfer of property under a Family Court order to a husband or wife from a private company will be treated the same as if it was paid under any normal circumstances.
This means it will be taxed either as an ordinary dividend or (potentially worse) a “Division 7A” deemed dividend.
If the payment or transfer is made to a shareholder of the company, it will be considered as an ordinary dividend paid out of the company’s profits (if any) and is frankable provided there are enough franking credits in the company. If the party receiving the cash or property is not a shareholder, they will be deemed an associate of a shareholder and taxed on the cash or property as a deemed dividend under Division 7A.
The (Thin) Silver Lining
Where a deemed dividend arises under Division 7A, the ATO accepts that the associate can be treated as if they were a shareholder for tax purposes which enables the company to fully frank the deemed dividend (an opportunity not normally provided to non-marriage breakdown circumstances).
Further, where there is a transfer of property (not cash), roll over relief may be available to defer any potential Capital Gains Tax (“CGT”) consequences to the private company. Though the relief means the accrued CGT liability effectively falls on the recipient of the property when they eventually sell. There can also be a cost base adjustment for the continuing shareholder!
Another ATO “U Turn”
In the past, the ATO had adopted a more generous interpretation of this issue and did not seek to apply Division 7A to the payment, provided the payment or transfer was pursuant to the terms of the Family Court Order. The ATO has acknowledged its “U-turn” on the issue and, accordingly, will not actively seek to review any orders made before 30 July 2014.
However, the ATO will apply its view in accordance with the Ruling for any such matters brought before the ATO for consideration, such as a private ruling application, effective 30 July 2014 even if the actual payment or transfer occurred before that date.
Seek help to avoid unexpected consequences
If you are currently attempting to negotiate a property settlement with a former spouse, do please talk to us. At the very least you will want to factor in the tax on divorce so that both parties are aware how much will be payable once settlement is reached (and therefore factor it in to planning and negotiations). However with luck, a better tax outcome can be found to help minimise the tax and maximise the marital asset pool available for distribution between the parties.