Paying property settlements with family business assets will result in new tax liability

Property settlements in some family law cases will be dramatically affected by the 2014 tax ruling. The ruling will affect divorcing couples when one spouse wants to retain ownership of a company (usually the family business) and, as part of a property settlement, causes the company to pay money or transfer property to the other spouse.

Until now, if the Family Court ordered a company to pay a sum of money or to transfer property to a spouse, that payment or transfer was not counted as a dividend. A draft ruling issued by the Australian Tax Office on November 13, 2013 provides that future payments of money or transfers of property by a private company to a shareholder (or the shareholder’s associate) in family law proceedings will trigger a “tax event.”

In simple terms, that means that the payment or transfer will be taxable. If the spouse receiving the payment is a shareholder in the company, the payment will be treated as a dividend. A spouse who is not a shareholder will be regarded as an “associate” of the shareholder and the payment will be treated as a constructive dividend.

It appears that the new ruling will not apply retroactively, although whether it will apply to transfers made after November 13, 2013 or only to transfers made after the rule becomes final is less clear. The draft ruling (3630) has been submitted for public comment.

The ruling will have the largest impact on wealthy families who own privately held businesses or trusts. The value of some property settlements for divorcing spouses in those families could be reduced by half.

The change will make a tax efficient property settlement more difficult to achieve in some divorces. Divorcing couples who may be affected by the new rule should consult a tax lawyer or tax accountant to discuss strategies to minimize the tax consequences of a property transfer from a family owned business. Strategies might include paying a divorce settlement from assets other than the family business. That will be difficult, however, if the business is the divorcing couple’s largest asset.

Another strategy might involve paying the divorce settlement from borrowed money, although incurring substantial debt