Divorce very often throws up tax issues and not only as a result of assets being split between the separated parties. These tax issues are not always obvious to separating parties and can surface after they have finished their property settlement.
Failure to deal with all taxation issues at the time the assets are being divided can have disastrous financial consequences for either one or both of the parties. It can mean one of the parties having to pay the Australian Taxation Office a substantial amount of money. This will comprise the 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.
The tax consequences that arise when assets are transferred between parties or sold are well known. Perhaps less well known is the fact that taxation consequences can also arise as a result of activities of one or both parties during their marriage or relationship. These are often unexpected at least to one of the parties and can impact of the value of the assets that are to be divided between the 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 as part of a property settlement is managed properly. For the same reason, it is also very strongly recommended that separating parties who operate a business or arrange their financial affairs through a company or family trust structure seek advice from specialist family lawyers.
Capital Gains Tax
With some limited exceptions, capital gains tax is payable on all transactions involving the transfer (or sale) of assets or property between parties. When a transfer of an asset is due to a marriage or relationship breakdown, there are special rules in the 1997 Income Tax Assessment Act that delay the imposition of that tax. This legislation refers to the process as `capital gains roll over relief’. Capital gains tax then becomes payable when/if the person to whom the asset was transferred, later sells the asset or property.
The most well-known of the limited exceptions to a liability to pay capital gains tax, is the transfer of the former family home to a spouse. This is tax free. The sale of the family home can also be an exception. Another exception is a transfer of cash. There is no tax payable on cash transfers.
Under the tax legislation, `capital gains roll over relied’ is automatic. This means that there is no choice in the matter. This may not suit everyone as there are some circumstances where capital gains roll over relief may be detrimental to a party. While this situation can be accommodated, expert advice is necessary when there is an anticipated transfer of assets between parties under the Family Law Act as each person’s circumstances are different.
Taxation is levied on all sources of income and not just 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, then the party in whose name the payments were received is liable to pay the tax on those payments without any contribution from the other party.
Tax Losses and Capital losses
A tax loss arises when the total deductions that can be claimed in any income year exceeds that person’s assessable income. A capital loss arises when a person sells or disposes of an asset for less than its cost base.
If tax losses arose during a marriage or relationship, the circumstances that gave rise to such losses can be of benefit to the party who is able to take advantage of them in the future. For that party, it means they will pay less tax on any income earned or profits that might be made in the future. Tax losses are therefore a valuable resource if available and if a party is in a position to take advantage of them.
Similarly, capital losses that result 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 role 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 very common kind of benefit is for a party to receive funds from a company. 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 will most likely be recorded as a loan from the company to that party in the company financial accounts.
The benefit can be received 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. More often than not those funds have been used for the benefit of the whole family or even used by the company.
Tax law regards these benefits as a type of income on which tax should be paid at the marginal rate of the person who received the funds. If nothing is done to correct the situation then the party in receipt of the benefits is liable for the tax owing on the value of the benefit plus an additional amount as a penalty for not paying the tax when it became due. This situation 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 of the asset 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 frankable. This means that the company transferring the asset can pay the tax on it up to 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.