A recent change in the ATO position on the treatment of payments and transfers of property from a private company under a Family Court order require careful planning to ensure unexpected and difficult to fund tax liabilities do not arise.
Late in 2013, the ATO issued a draft public ruling on the taxation of payments made by private companies in connection with proceedings under the Family Law Act (FLA). The ATO has now issued its final ruling on this matter, which reverses its long held view that payments made by a private company to a shareholder or associate, under an order of the Family Court, would not be regarded as taxable dividends to the recipients. This ruling now closes off this tax effective means of settling monetary agreements where a private company is joined in the proceedings.
The ruling applies prospectively only. It will not be applied to a Family Court order made prior to 30 July 2014. Any payments or property transfers made after that date in compliance with a Family Court order made prior to 30 July 2014 will not taxed in accordance with the new ruling, unless this should be more favourable to the parties.
Effect of ATO ruling
Pursuant to the FLA, the Family Court is able to make orders directly against a private company of which one or more of the parties to the court proceedings are shareholders. The FLA also requires the court to take into account the taxation implications to the parties which arise from the order.
The ruling states that if money or property is transferred by a private company to a shareholder or associate pursuant to an order of the Family Court, such a payment or transfer will be treated as a taxable dividend to the recipient. Depending on the circumstances, such dividends can be franked. Under previous ATO practice, such payments or transfers were not treated as taxable dividends. This practice allowed related companies to make tax free transfers of money or property to related parties engaged in the proceedings, thereby facilitating a tax effective resolution of Family Court orders.
The ATO’s view expressed in the ruling is that the payment of money or the transfer of property by a private company in accordance with the FLA will be taxed in the following manner:
- If to a shareholder and paid out of retained profits, the amount will be an ordinary dividend, capable of being franked.
- If to an associate of a shareholder, eg. a spouse or former spouse, the payment or property transfer will be deemed to be a dividend, also capable of being franked.
- If a deemed dividend is by way of property transfer and the value of that property exceeds the ‘distributable surplus’ of the private company, the taxable amount is restricted to the distributable surplus, i.e. the excess of assets over liabilities, at book values.
The prior ATO practice was based on the premise that a payment to a shareholder or associate was the discharge by the company of its obligation to pay money, or transfer property, arising from a court order. However, the ruling now reverses that practice by taking the view that such payments can never be exempt from the dividend provisions of the tax law. It states that in the absence of the family law order, the company would not enter into such transactions. As such, they are not regarded as being at arm’s length.
Accordingly, any payment by the company under such an order will be a fully taxable dividend, capable of being franked.
Capital Gains Tax rollover relief
The Capital Gains Tax provisions include rollover concessions relating to property transferred in consequence of divorce proceedings. The ruling confirms that those provisions do apply in the context of transfers referred to in the ruling, and sets out the specific consequences to the parties. The consequences are:
- To the company - it will disregard any gain or loss arising from the transfer of property.
- To the recipient - the transferee of the property will inherit the same cost base as the company had at the date of transfer. If the property is a pre-CGT property to the company, it will retain its pre-CGT status to the recipient.
There are also consequences for the cost base of certain shareholders’ interests in the company. These consequences may, in certain circumstances, result in an uplift to the cost base of those interests.
Where the transferee is not a shareholder, the cost base of the interest will be decreased by the market value of the property however no uplift applies.
Where to from here?
Clearly the ruling has dramatically changed the landscape for the drawing of separation orders involving private companies. Therefore very careful consideration of the consequences of this ruling will need to be given, not only the Family Court judges, but also the legal and accounting advisors to the parties.
How can we help?
If you have any doubts or questions about your circumstances we invite you to contact Bruce Sainsbury, or your usual adviser at Baumgartners, to discuss the ATO’s new position.
Family Law and Valuation Specialist
Prior to joining Baumgartners in 2012, Bruce gained extensive experience in number of high profile roles across both practice and commerce. Bruce spent time abroad as manager of an international office of Price Waterhouse, and as the Hong Kong based taxation manager of a large multi-national corporation. More recently he has developed an enviable profile as an expert in litigation support on matrimonial matters.