Individuals often hold their assets in a variety of entities, be they companies, trusts or other types of arrangements. In the context of family law, divorcing spouses have often funded their divorce settlements using assets held by private companies. This is because family law settlements do not attract tax in the way normal commercial transactions might.However, on 30 July 2014 the Australian Taxation Office (“ATO”) issued a final public ruling making it far more difficult for spouses to use income and other property held in a private company to fund property settlements tax free. Instead, payments made from private companies will now be considered ‘dividends’ and subject to personal income tax by the shareholder. Depending on the marginal tax rate of the spouse involved, a tax of up to 49% of the gross figure could be payable, reducing a divorce settlement by almost half. The difficulty applies to all couples, regardless of whether their companies have $100 worth of assets or $1,000,000 worth of assets.In addition to the increased cost of divorce, some commentators have warned that the need to fund a divorcing spouse’s tax bill could convert a 50-50 settlement into a 60-40 settlement or worse, resulting in an obvious inequity between the parties. Further, for those companies that are already struggling financially, the need to make a large payment to a divorcing spouse and also fund that spouse’s new tax bill could have dire consequences for the company’s success.
To reduce the tax liability, parties might choose an alternative way to divide their assets upon divorce. For example, it might be possible to provide the divorcing spouse with another asset, such as a property or a motor vehicle, or a spouse might be paid from a non-company entity, such as an individual or a trust, by using the company’s assets as security. Alternatively, a company restructure might enable a spouse to receive shares in the company instead. In this regard, a spouse can take advantage of the Capital Gains Tax (CGT) rollover provisions and defer any tax payable until another CGT event occurs (such as selling the asset to someone else). However, divorcing spouses must ensure that such a restructure does not contravene any of the ATO’s anti-avoidance rules.Unfortunately, not all divorcing spouses will have these options available and in such circumstances, the extra tax liability must be considered early on and apportioned appropriately between the parties. A good understanding of the tax ramifications of any property settlement will be key to ensuring the after tax split between the parties is not a nasty surprise. Accordingly, it will be important for divorcing spouses to receive specialist advice from experienced family lawyers, taxation lawyers and in some circumstances, accountants. If you are thinking about getting divorced or have any questions about the implications of the new tax ruling, please contact our office and speak to one of our experienced solicitors.