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Transferring assets between spouses as part of a divorce does not always mean 0% tax. Rollovers and exemptions can usually remove the CGT and stamp duty costs, but in some situations tax of up to 46.5% can be triggered.
The tax problems arise where a company or trust is involved. The transfer of assets from these entities can inadvertently trigger other issues such as Division 7A.
Fortunately, with a thorough understanding of how the marriage breakdown provisions within the tax laws operate, potential tax problems can not only be overcome, but utilised as a planning opportunity.
Can you turn your clients’ tax issues into a planning opportunity?
Transfer of assets on divorce
The settlement of a marriage breakdown generally involves the allocation of assets between former spouses. For clients who have businesses or more complex structures, this may also involve the transfer of assets from companies or trusts to one of the parties to the marriage.
The CGT provisions allow for any capital gain realised from the transfer of an asset under a marriage breakdown to be disregarded if the transaction is completed in the appropriate manner. The CGT exemption not only applies to a spouse who is required to transfer an asset, but also to a company or trust that is required to transfer an asset to one of the former spouses.
Where an asset is transferred from a company (and some trusts) to one of the parties to the divorce, Division 7A implications can be triggered. Many practitioners (and family lawyers) are aware of the CGT and stamp duty rollovers, but fail to consider the Division 7A issues. Generally the transfer of an asset from the company (or trust) will result in Division 7A implications, even if it is under divorce proceedings.
If Division 7A is triggered, a deemed unfranked dividend can arise for the party to whom the asset has been transferred (which may be a different party to the actual shareholder of the company). This can result in a 46.5% tax liability.
The Division 7A provisions allow a deemed dividend arising under family law (divorce) proceedings to potentially be franked. Despite this, the party to whom the asset is being transferred could still be left with a tax liability equivalent to 23.57% of the current market value of the asset.
While the ability to frank the dividend provides some relief, practitioners should consider whether even greater opportunities are available to their clients to reduce the tax liability to nil (or possibly even a refund).
Bob and Mary have been married for many years.
Unfortunately they have recently separated and have decided to get divorced.
They are in the process of splitting their assets and are considering how to deal with ABCD Pty Ltd, a private company wholly owned by Bob.
The only assets of ABCD Pty Ltd are a business worth $1 million and cash of $1 million. The company has no liabilities.
The parties have agreed that Mary is to get the cash and Bob the business.
If the cash is simply paid to Mary, she could end up with a tax liability of $465,000 in the year she receives the cash. If the divorce agreement is not drafted appropriately, she may have to pay the tax from her share of the assets (meaning that she really only ends up with $535,000 of cash after paying her tax).
Could this tax liability be reduced – potentially to nil (or even a refund)?
In order to achieve this reduced tax liability, it may be necessary to ‘think outside the square’.
Perhaps the company could effectively be ‘split’ into two separate companies – one which Mary takes (containing the cash), and the other which Bob retains (containing the business)?
Perhaps CGT concessions could be utilised to transfer the business out of the company (to Bob), with Mary acquiring the company containing the cash?
Perhaps a Division 7A franked dividend could be paid to Mary, despite her not being a shareholder in the company?
Planning opportunities on divorce
Often advisors overlook the significant planning opportunities which can be available to their clients in divorce situations. While you may not be able to repair the marriage, you may be able to provide some (rare) good news for the parties if you can spot some opportunities for them to restructure or otherwise split the assets in a more effective manner.
Situations to look out for which commonly present significant planning or restructuring opportunities include:
- Assets held within companies or trusts;
- Businesses or business premises (whether held directly or through an entity such as a company or trust);
- Redundant structures, such as companies or trusts which previously operated, but are no longer required; or
- Companies where one of the former spouses isn’t a shareholder, but may wish to receive assets (including cash) from that company.
The Tax Services team at William Buck have significant experience in developing tax effective ways for assets to be transferred between parties in marriage breakdown situations and to assist in implementing appropriate structures for the future. Should you have any clients who are going through divorce proceedings and could benefit from a review of how the assets may be divided in the most tax effective manner, please contact your local William Buck advisor.