Divorce and the associated financial settlements can be a difficult time both emotionally and economically at the best of times. Now under a new Australian Taxation Office (ATO) taxation ruling the process can be even more taxing in some cases.
With the issue of its tax ruling TR 2014/5 in July 2014, the Australian Tax Office (ATO) has reversed its view on payments and transfers of property made to shareholders and their associates in a private company in family law proceedings
The ATO has advised that cash payments or transfers of property from private companies to individuals in family law proceedings will be treated as dividends from those companies. The effect of the Ruling is funding of a property settlement from money or assets of a private company will now be subject to income tax, less any applicable franking credits, payable by the recipient. Previously these payments by way of a Family Court order would have been treated as tax-free for divorcing couples.
The position taken by the ATO before the Ruling, provided that if the company was obliged under s 79 of the Family Law Act 1975 to make a payment, such payments would be considered as discharging an obligation by the company and not a distribution of profits therefore would not be taxed as dividends.
Previously parties to family law disputes would utilise s 109J of the Income Tax Assessment Act 1936 which enabled cash payments from private companies to associates to be considered as discharging an obligation…to pay money, rather than a distribution of profits from the company. As a result, payments ordered to be made by companies under s 79 were exempt from the operation s 109C which would otherwise have deemed such payments to be dividends and therefore “assessable income”. For those separating couples who had utilised private company structures to build wealth the previous application of 109J assisted the parties and the courts to effect just and equitable financial settlements without the burden of additional tax.
As the Ruling has the potential to increase impose a large tax bill on payments that were previously tax free it is important for separating couples to seek legal advice when determining the matrimonial pool of assets to ensure an equitable division for each party.