Company payments pursuant to Family Court Orders assessable income to recipient
Steve Potts (5 August 2014)
On 30 July 2014 the Australian Taxation Office (ATO) issued a Tax Ruling specifically targeted at payments or transfers of property by a private company in compliance with a Family Court Order, whether in contested hearings or by consent.
While the Ruling addresses the provisions of the Family Law Act that deal with adjustments to matrimonial property, the methodology for adjusting property interests of de facto couples is paralleled in the Family Law Act and we consider the approach adopted by the ATO would be the same.
Payments or Transfer of Property
It is not uncommon for the Family Court to order a private company, or a party to the proceedings to cause a private company, to make a payment to another party to the proceedings or to transfer property to them.
Since 2004, the Family Court has had the power to make orders against third parties, such as companies in which one spouse is a shareholder. The Ruling acknowledges the Family Law Rules will often require a company to be a party to the court proceedings but does not mention that similar provisions are not found in the Federal Circuit Court Rules (the Federal Circuit Court being the court in which the vast majority of matrimonial proceedings are commenced and resolved).
The Ruling
Under the Ruling, the payment or transfer of property is an ordinary dividend of the company and assessable income under the Income Tax Assessment Act 1936 (Cth) (ITAA 1936). A ‘dividend’ is defined in the ITAA 1936 to be ‘any distribution made by a company to any of its shareholders, whether in money or other property’. Earlier Rulings by the ATO about distributions from companies state that so long as the market value of the company assets exceeds the total amount (as shown in its books of account) of its liabilities and share capital what remains is profit. If the distribution to the spouse is not debited to share capital, the distribution is one of profits.
It does not matter that the directors of the company may have been compelled to make the payment or transfer the property because of the Family Court Order, it will still be characterised as a dividend and taxable in the hands of the recipient.
Furthermore, where the payment is made to an associate of a shareholder the ATO considers the payment will be a deemed dividend for the purposes of Division 7A of the ITAA.
Where an Order requires the transfer of property, existing Capital Gains Tax rollover provisions continue to apply.
Consequences of the Ruling
We consider the Ruling raises potential difficulties for parties who are seeking a commercial or pragmatic resolution to their matrimonial separation and their ongoing business arrangements. For example:
- The amount to be paid to a spouse by a company may be calculated by reference to issues that are far broader than the identification of retained profits used by the ATO.
- The determination of the value of a business for Family Law purposes may be on a completely different basis to that used by the ATO, giving rise to a disparity in the amount of any payment to be made and how much will be characterised as a payment from retained profits; and
- In the eyes of the Family Court, the business may be ascribed a value as an ‘asset’ of the relationship but once a payment is made in compliance with an Order, part or all of it may change its character and become income in the hands of the recipient, reducing the overall matrimonial pool.
These issues will have serious consequences. Parties will need to address the Court about questions such as how tax consequence of the payment will be borne. Parties will also need to consider what use may be made of marginal tax rates of the individual recipient and how they may differ to that of the company.
In view of these challenges:
- It will be incumbent on parties to ensure the Court is provided with clear, expert evidence about the likely tax consequences to the company and the recipient. This ought to be done at the earliest opportunity, as it may have significant cash flow consequences to the company. Considered advice at the outset may bring significant savings and prevent unintended tax consequences;
- Consideration will need to be given to existing caselaw developed by the Family Court for dealing with Capital Gains Tax;
- Where the tax effect is not taken into account, a party to the Order may have a basis to apply to the Court to set aside the Order and make another in its place. While this may seem appealing to parties who have been inconvenienced by the Ruling or an Order, the cost of additional litigation will need to be thoughtfully considered; and
- There may be significant advantages to parties who enter into Binding Financial Agreements which can settle parties’ financial affairs and create obligations outside of the Family Court.
For further information about the Tax Ruling and how it may apply to your business, contact us.
DISCLAIMER: This update contains general information only. The information is not all inclusive and should not be considered to be legal advice. You should always obtain legal advice for your specific circumstances before relying on general information.