Tax implications for when divorcing

The tax effect of proposed family law orders is a material consideration for practitioners operating in that space.
If one spouse party accrues a significant personal tax liability because of inter-relationship activities of both parties or the other party, and can’t pay that liability, he or she may be able to obtain an order from the Family Court binding the Federal Commissioner of Tax (FCT) to substitute him or her for the other party.

That type of tax debt can accrue when the party has limited or no control over the family assets or income that the other party is managing. It can accrue because of income splitting or distributions through trusts but when the other party controls the use of that money.

If the debt accrues and the relationship breaks down, the party controlling the money may be able to control it such that the party with the debt has no capacity to pay and interest and penalties accrue, multiplying the debt. The result can be very unfair. The Court may now order the FCT to substitute that party for the other, even if the one substituting is bankrupt and his or her estate is controlled by a trustee.

The power of the Court is in s.90AE of the Family Law Act, subject to specific conditions for the exercise of the discretion. The High Court of Australia’s decision in Commissioner of Taxation v Tomaras [2018] HCA 62 focussed on whether the proper construction of s.90AE conferred jurisdiction on the Court to bind the FCT in such orders; the conclusion being it can. The consequence may have a material impact on how certain family law cases may play out.

If the transfer of assets between parties or their entities are being considered in family law settlements, thought should be given to whether capital gains tax rollover relief could be available to the transferor through Subdivision 126A of the Income Tax Assessment Act 1997.

A lesson from Ellison v Sandini Pty Ltd ]2018] FCACF 44 is that consent orders fashioned to achieve rollover relief, may not achieve what they intend. For example, care should be put into properly identifying any trustee entity transferring the asset, so its capacity in which it holds the asset is precisely defined. If it is not, the Court’s orders may be ineffective. Further, care must be taken to ensure that if the transfer is from a corporate entity, the transfer is to spouse party itself, not another corporate entity nominated by the spouse party. If that does not happen, transferor may be unintentionally liable for tax on the capital gain.

Further, the future capital gains tax and income tax liability of a party as a result of proposed orders needs to be understood in case it can lead to a future unforeseen liability that would lead to an injustice if not thought about at the time the orders are made.

Transfers of assets or income to a spouse party that is a shareholder of the transferor may also attract personal income tax as a “deemed dividend” under Division 7A of the Income Tax Assessment Act 1936. This is contrary to what may be assumed.

It may be wise to slow down the negotiation to obtain tax advice or to reserve the making of the orders pending tax advice on one particular issue, to avoid adverse unforeseen consequences. That approach may not be appreciated by the other party, but if a mistake arises because that step is not taken, your client will not be as happy as you hoped.

Article by Giles Stapleton, 9 Selborne Chambers, Sydney, gstapleton@selbornechambers.com.au