CGT, deemed dividends and stamp duty: The consequences of not taking into account tax in family law matters

In the majority of family law property matters, parties tend to reach an agreement without requiring a determination from the Court and thereafter formalise that agreement by way of Consent Orders or a Financial Agreement. However, parties often neglect to obtain tax advice about the effect of the orders which can lead to one party incurring a liability following the agreement being formalised that should have been factored into the settlement.

This article outlines the common and not-so-common tax consequences that tend to arise in family law property settlement matters that would trigger a referral to an accountant or specialist tax lawyer for advice.

Capital gains liability

At the outset, the Income Tax Assessment Act 1997 provides an exemption from capital gain tax if you can demonstrate that the property is your main residence or home. To obtain a full, not partial exemption you must demonstrate the property:

has been the home of you, your partner and other dependents for the whole period you have owned it
has not been used to produce income – that is, you have not run a business from it, rented it out or ‘flipped’ it (bought it to renovate and sell at a profit)
is on land of 2 hectares or less.

In family law matters where one property is transferred to another, provided that person continues to use that property as their main residence, the exemption will still apply.

Capital gain becomes a significant factor when the property is an investment property or otherwise is not eligible for CGT. A common misconception is that provided the transfer of such property occurs via a consent order or financial agreement such document provides an exemption. It does not. It provides roll-over relief which effectively simply moves the CGT to the person acquiring the property to later be calculated at the next CGT event (e.g. further sale or transfer). An accountant can undertake a calculation of what that liability will be adopting in a future value of the property.

Deemed dividends

Another commonly missed tax consequence is transfers in relation to a company including the forgiving of a debt held owed by a party to the company. The provisions of Div 7A of the Income Tax Assessment Act 1936 provide that the following can be deemed as a dividend to a person and thus subject to a tax consequence:

Where a company makes a payment to an associate of a shareholder such as their former partner/spouse.
Where a company transfers a company asset such as a vehicle to an associate of a shareholder.
Where a company makes a loan; and
Where a company forgives a debt.

Stamp duty

This is state-based but in NSW generally, transfers of property between parties that are documented in a financial agreement or consent order are exempt from paying stamp duty.

Court’s approach to yet-to-be-incurred tax liabilities

Whether to include such liabilities noting they have not actually been incurred yet is something that has been heavily litigated.

In Rodgers & Rodgers (No 2) [2016] FamCAFC 104 the Court reminded parties that that there is no rule that all liabilities must be deducted from the net assets. There still must be an assessment of the nature of the liability, the circumstances surrounding the liability and the dictates of justice and equity shaped by each. The Court said it was less likely to take into account vague, uncertain, or unlikely-to-be-enforced liabilities.

The seminal case on the issue is Rosati and Rosati [1998] FamCA 38. In this case, the Court outlined some general principles for the inclusion of not yet incurred tax liabilities:

There needs to be an assessment of the liability including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
If the court has ordered the sale of the asset or is satisfied that the asset will probably be sold, or it is inevitable it will be sold, an allowance should be made for any CGT payable upon the sale.
If the court is not satisfied of the above but is satisfied that there is a significant risk that the asset will have to be sold in the short to mid-term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s.75(2) factor (married)/ s.90SF(3) (defacto). This tends to not be a dollar-for-dollar adjustment.
There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset.

Finally, the High Court has held in the case of Commissioner of Taxation for The Commonwealth v Tomaras & Ors [2018] HCA 62 that the Court does have the power to direct the Commissioner of Taxation to substitute one spouse for another with respect to taxation liabilities.

Not obtaining appropriate legal and accounting advice in a family law property settlement can be disastrous for a party. If you have a property settlement matter involving trust, companies, businesses or investment properties please contact our firm on (02) 4944 3322 to make an appointment with our Accredited Specialist in Family Law, Mr Hayden Carr.