Relationship breakdowns very often throw up taxation issues and not only as a result in a redistribution of assets between the separated parties. These taxation issues are not always obvious to the parties and can surface after a property settlement has been finalized. Failure to deal with all taxation issues at the time the assets are being divided can have disastrous consequences for either one or both of the parties.
It is therefore very strongly recommended that separating parties who operate a business or arrange their financial affairs through a corporate or trust structure seek advice from specialist family lawyers.
The taxation consequences that arise when assets are transferred between parties or sold are well known. However, taxation issues can also arise even where assets are owned by one party alone. These must be managed in any property settlement.
Perhaps less well known is the fact that taxation consequences can arise as a result of activities of one or both parties during the period of their relationship. These are often unexpected and can impact of the value of the assets that are to be divided between the parties.
If the taxation issues are not dealt with, they can and often do arise after a property settlement has been finalized. This may mean one of the parties having to pay the Australian Taxation Office a substantial amount of money comprising an unpaid tax liability and an additional amount as a penalty for failure to pay the tax liability when it became due. This will be particularly upsetting for the party having to pay when the debt arose during the relationship and so should have been shared by both parties.
If this outcome is to be avoided it is critical that expert advice is sought from specialist family lawyers to ensure that any change in the way assets are held or transferred between parties is managed properly.
A very brief overview of the taxation issues that arise in relationship breakdown is given below.
Capital Gains Tax
With some limited exceptions, tax is payable on all transactions involving the transfer (or sale) of assets between parties. When a transfer is due to a relationship breakdown, there are special rules the Family Law Act that delay the imposition of that tax. Tax legislation refers to this process as `capital gains roll over relief’.
The most well known of the limited exceptions, is a transfer of the former family home to a spouse. This is tax free. Another exception is a transfer of cash. There is no tax payable on cash transfers.
Capital gains roll over relief may or may not be of benefit to a party. As each person’s circumstances are different, expert advice is necessary when there is an anticipated transfer of assets between parties under the Family Law Act.
Taxation is levied on all sources of income not only from paid employment. Payments a party may have been receiving from a family company or dividends from shares are examples of income on which tax has to be paid. This is the case even if those payments go into a joint account or account held in the name of the other party. If this liability is not addressed during the process of dividing assets between parties, the party in whose name the payments were received is liable to pay the tax on those payments.
Tax losses and capital losses
The importance of tax losses that arose during the relationship is being able to take advantage of them in the future. For the party who is able to retain tax losses, it means a reduction in the taxation liability arising from profits that might be made in the future. They are therefore a very valuable resource if available and if a party is in a position to take advantage of them.
Similarly capital losses that might arise from the sale of an asset can be a valuable future resource in the right circumstances.
Loans, payments and other benefits received from a family company
It is common for a party who has no formal interest in a family company to receive a benefit as a result of the other party’s involvement in the company. An example of such a benefit is the use of a company car or a boat owned by a company.
Another common kind of benefit is for a party to receive funds from a company. Very often the payments are not shown in the receiving party’s income tax return and so income tax is not paid on them. Those funds might be treated as a loan rather than just a payment in the company financial accounts.
The receipt of such a benefit can occur over many years with the party in receipt of those funds not realizing or knowing that tax should be paid on those payments or how they are treated in the company books.
Tax law regards these benefits as a type of income on which tax should be paid. If nothing is done to correct the situation then the party in receipt of the benefits is liable for the tax owing on their value plus an additional amount as a penalty for not paying the tax when it became due. This may not be uncovered until after a property settlement is finished.
When an asset is transferred from a company to a party as a result of a property settlement under the Family Law Act, tax is payable on the value of the asset being transferred. Tax law deems the value to be a dividend paid by the company to the party and the party is liable for the tax that is payable on the dividend amount.
The concession allowed in a family law situation is that the `dividend’ is franked. This means that the company transferring the asset can pay the tax on it at the rate of 30%. This in turn may mean there is no tax to be paid by the receiving party if his or her marginal tax rate is 30% or less.