The ruling will affect divorcing couples when one spouse satisfies a Family Court order to pay the other by using money or property held by a family business. While those payments were once regarded as tax free, they will now be treated as a “tax event” that triggers an obligation to pay taxes on the value of the transfer.
Families with significant wealth often “park” some of their money in a family-owned corporation to take advantage of the lower corporate tax rate. As the corporation earns income, it pays tax at a 30 percent rate. Since the marginal tax rate paid by the most highly compensated Australians is 46.5 percent, they gain a tax benefit by letting a family-owned corporation earn and keep income rather than paying it to themselves. A similar tax advantage applies to family trusts and to certain partnerships.
Before the Tax Office ruling took effect on June 30, a property settlement could be structured to take advantage of legal interpretations that allowed a divorcing spouse to make tax free payments to the other by transferring money or other assets held by an incorporated family business. When a Family Court ordered a company to make those transfers, they were not treated as a taxable dividend. The new ruling treats the transfers as a dividend that must be taxed.
A divorcing spouse who receives a payment from the corporation will be regarded as an “associate” of the ex-spouse shareholder and the payment will be treated as a constructive dividend. Dividends are taxed at the personal rate.
The Tax Office ruling was first proposed in November 2013, so couples anticipating divorce had time to take advantage of the former rule before it took effect. Now that the new ruling is in place, it may be more difficult to fashion property settlements when one spouse’s wealth is tied up in a family business or trust. While a divorcing spouse could benefit from tax free transfers before June 30, the spouse receiving the money or assets will now lose up to 46.5 percent of the property settlement to tax payments. Family Courts may respond to that loss of value by requiring the shareholder making the payment to pay larger sums to help offset the tax burden that the spouse receiving the payment will incur.
The potential need for the spouse who owns a family business to pay more is likely to make property settlements more difficult to achieve.
This article provides basic information only and is not a substitute for a professional or legal advice