You’ve been out of university for a few years working in a business law firm that also does a bit of family law now and then. Because of your interest in family law, you’ve had quite a bit to do with it in those few years and love the challenge of helping people sort their various relationship problems. Your best friend, John, comes to see you as his marriage to Linda has finally collapsed as she refuses to call off a long standing affair with a local doctor.
You are concerned about acting for John given your limited experience and your friendship. But he is extremely distressed and wants to talk to a lawyer ‘he trusts.’ You’ve always been quite fond of John and feel sorry for him so you relent and agree to act for him.
Linda is a successful vet and runs her practice through a company. They have no children.
Despite the situation John is a reasonable guy who wants the split to be quick and as amicable as possible so you quickly arrange to have a meeting with John, Linda and Linda’s solicitor. Because all of Linda’s wealth is in her company, it is agreed in the meeting that her company will make a payment of $500,000 to John and that John will transfer his interest in their residence to Linda.
Your first concern is how the transfer of the residence to Linda will be treated for tax and duty purposes. You seek the advice of another more experienced solicitor in the firm and he confirms there is a CGT exemption on a marriage split pursuant to s.126-5 of ITAA 1997 and that s.68 of the Duties Act 1997 gives an exemption on transfer of “matrimonial property” under a Family Law order.
Excellent, you think. I can get this all sorted for John at minimal cost. You tell John what you have worked out, finalise and file the consent orders, complete the transfer, the company makes the payment to John and you consider the matter done and dusted. John is extremely grateful for all your work so drops in a bottle of Dom Perignon.
John phones you a couple of months later confused. He said there has been an audit and his accountant has told him he has to add $500,000 to his assessable income for the year.
You hang up the phone feeling sick to the stomach and immediately rush to see the solicitor who gave you the advice about CGT and stamp duty. He glares at you over the top of his glasses and says ‘you didn’t mention anything about a payment by the company, what about Division 7A?’
Division 7A of the ITAA 1936 says that a payment of money by a company to an associate of a shareholder is a taxable dividend.
You think to yourself, surely there must be some kind of exemption when it is connected with a marriage breakdown – so you start to do some research.
You find a section that gives you some hope. Section 109 J of ITAA 1936 excludes a payment from being treated as an assessable dividend to the extent it discharges an obligation of the company to pay money.
However, on further reading of the section you find yourself struggling with paragraph (b) of the section which says that the amount paid must not be more than the amount that would be payable if the company and spouse were dealing with each other at arm’s length.
You then find a private ruling where the ATO stated that provided there was a Family Court order binding the company, as a party to the proceedings, is an explicit order binding the company to specifically pay cash to the rulee, and not some other alternative obligation, the payment would not be considered a dividend by virtue of section 109J of the ITAA 1936.
Unfortunately you did not make the company a party to the proceedings, so this ruling offers little comfort. On conducting further research, you find a ruling TR 2014/5 where the ATO has changed its view anyway. This ruling says in part:
“Where a section 79 order requires:
- a private company, or
- a party to the matrimonial proceedings to cause the private company,
to pay money or transfer property to an associate of a shareholder of property in compliance with the order, the payment of money or transfer of property is a payment for the purposes of subsection 109C(3) of the ITAA 1936.
Section 109J of the ITAA 1936 does not prevent the payment from being treated as a dividend under subsection 109C(1) of the ITAA 1936.
You scramble to find some thread of hope. Under s.109RB the Commissioner can disregard the consequences of Division 7A in the event of “an honest mistake or inadvertent omission” which may be worth a try, but you don’t like your chances given the Commissioner has to be satisfied and it is not automatic.
Section 109 RC also gives some hope. This section applies if a dividend is taken to be paid because of a family law obligation and means the payment can be made as a franked dividend, so the franking credit would reduce the tax – assuming there are sufficient franking credits in the company.
Despite the above, John will still have a hefty tax bill to pay. You prepare to give John the bad news and, with dismay, return the bottle of Dom Perignon.
Author: Amanda Tully
This article is general information only and should not be relied on without obtaining further specific information.