It comes as no surprise that the Tax Office has delivered its TR 2014/5 finding that distributions of property or money from a company as a consequence of Family Court Orders constitute assessable income. TR 2014/5 does, however, remind practitioners and parties that Tax Contingency Reports must be considered.
Whilst there exists significant roll over reliefs (essentially deferral of capital gains) and stamping exemptions arising as a consequence of Family Law Orders, the question is now answered definitively by the Tax Office that transfers of property or money, from a company structure in satisfaction of a claim to a family law property pool, are taxable.
It has been argued previously by a minority of tax practitioners that the transfers obligated as a consequence of Family Court Orders (section 79 of the Family Law Act 1975) constitute a “discharge of an obligation” by the company. This position, however, was at odds with section 44 of the Income Tax Assessment Act 1936 (ITAA 1936) which otherwise defined a dividend (in other words, assessable income) to be a payment out of profits of a company to a shareholder (or associate of the shareholder) and section 207 of the Income Tax Assessment Act 1997 (ITAA 1997) which deals with the availability of tax offsets (franking credits) in relation to dividends to shareholders (or associates). Certainly, within the context of Division 7A of ITAA 1936, the position has been that a payment, use or guarantee of company assets constitutes a deemed dividend.
In short, the Tax Office has its hand up whenever company assets are distributed or used for other than generating assessable income to the company. The upside of utilising the company as an operating entity is to quarantine (and recycle) profits at a 30% tax rate, until such time as determined reasonable to distribute the profits to shareholders (and/or associates). As confirmed by TR 2014/5 – the breakdown of a relationship does not change this position (reference includes an associate of a shareholder). Therefore, it is critical for parties to consider not only the equity of the family pool division – but also the tax consequences (and indeed the cash flow funding) of the proposed division.
A common situation arises wherein a husband and wife have conducted their family business through a company, and have retained profits. For this example, let us assume the couple have retained profits of $1,000,000 in the company, with cash in bank at $1,500,000. We shall further assume the company has a net market value (including assets and goodwill) of $5,000,000. Let us also assume the couple hold real estate in a family trust controlled by the couple that is worth $1,500,000. Finally, we assume the couple has a primary residence with a net value of $500,000.
Setting aside the potential for small business concessions and legal tax planning options, if the parties conclude that the wife should receive control of the family trust (valued at $1,500,000) and the family home (valued at $500,000), and a cash payment of $1,000,000 from the company and an asset of the company valued at $500,000 – this is not going to result in a 50/50 after tax outcome to the wife.
In fact, the $1,500,000 benefit from the company will attract tax at the wife’s marginal tax rate (in the ballpark of $650,000!). Whilst the company may be able to frank the payment to the wife, she will nonetheless bear a tax consequence of 16.5% of the franked dividend (in this case it could be in excess of $320,000!).
Therefore, it goes without saying that TR 2014/5 forces tax to be a significant factor in family law negotiations.
Katrina Brown, Senior Lawyer with Nautilus Law Group, authors Tax Contingency Reports for parties seeking definition of the possible tax contingencies factorable in property settlements. Consideration given in the Reports includes availability of franking banks (available for offset against tax payable on assessable income in the hands of a shareholder of associate), capital gains tax roll over reliefs and small business concessions, and funding options for legal entities operated in a family group. Further, it is often the case that non-family related business proprietors are associated with legal entities which are subject to family law proceedings (or threatened to be compromised as a consequence of such proceedings). The Reports, therefore, also have regard to best case outcomes for the non-family business proprietors.
If you are interested in speaking with Katrina Brown regarding Tax Contingency Reports, please feel free to arrange a meeting by our offices on (07) 5574 3560.
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