This article was published in this month’s edition of the Law Society Journal of NSW.
You are acting for Jeremy in relation to the breakdown of his marriage with Chloe. Jeremy tells you that he and Chloe have reached a property agreement with the assistance of a mediator. Jeremy explains that the family assets are the family home in his name and Chloe’s company Tiger Sports Pty Ltd, which conducts extreme sports events world wide and has a high net worth and celebrity client list. Chloe is the sole shareholder and director. Jeremy is a practising physiotherapist with a quiet suburban practice. They have three teenage children who, Jeremy ruefully admits, find dad somewhat boring and love to be involved with mum’s business.
While Chloe’s business has been very good, her expenses are very high given the need for international travel and marketing. So, while Chloe is asset rich she never has much surplus income. Jeremy’s patients are from low socioeconomic backgrounds and he does a fair bit of pro bono work.
Chloe is sympathetic to Jeremy’s situation but she needs the house to look after the kids now. While Jeremy recognises this, he is extremely reluctant to give it up. Eventually Jeremy agrees to transfer the house provided Chloe gives him the option to buy it back at a 50% discount when the kids grow up and Tiger Sports transfers to him the investment unit it owns.
So, the deal is that (A) Jeremy will transfer the house to Chloe (B) Tiger Sports will transfer the unit to Jeremy (C) Tiger Sports will pay Jeremy $250,000 and (D) Chloe will grant Jeremy a legally binding option to buy back the family home when the youngest child moves out.
You had a similar matter a few years ago and are aware of the peril of Division 7A of Income Tax Assessment Act 1936 which provides that a payment or transfer of property by a company to an associate of a shareholder can be taxed as a dividend.
You dig out the advice you had from a specialist solicitor that according to private binding ruling number 1012373245500, provided the company was joined as a party to the proceedings, section 109J ITAA 1936 applied to exempt the payment. You explain this to Jeremy who is suitably impressed.
You contact Chloe’s solicitor, Charles, to take things further and are surprised by his aggressive manner. Charles tells you he is pushing Chloe to take the matter to the Family Court to obtain justice. Discussions therefore don’t go far.
Nevertheless, after some ups and downs the mediated agreement is finalised in the form of consent orders, including an appropriate order for Tiger Sports to transfer the property and make the payment.
Then you get a call from Jeremy’s accountant, Jean. Who isn’t happy.
Firstly, Jean explains, in 2015 the ATO issued ruling TR 2014/5 which reversed the position so far as payments from a private company to an associate of a shareholder pursuant to Family Court orders so that the payment of $250,000 is assessable income. Then it gets worse as Jean explains that the transfer of property is also taken to be a dividend of an amount equal to the market value under Division 7A.
Jean explains a slight relief is available in that the payment can be franked which reduces the tax input somewhat – section 109RC ITAA 1936. On the other hand, Jean says, because the transfers pursuant to a Family Court order, under section 126-15 ITAA 1997, the company will not have to pay capital gains tax.
Realising the unfairness you decide to speak to Chloe’s solicitor Charles to request that the matter be looked at again to even things up a bit. Charles’ response, essentially to get stuffed, at least clarifies the situation quickly.
A few days later Jean telephones to say she has looked at things a bit further and that Chloe’s option for Jeremy to buy back the family home will cause Chloe a problem. Jean tells you that CGT event D2 under section 104-40 ITAA 1997 happens when an option is granted, that this CGT event is not exempted under section 126-15 ITAA 1997 and that the market value substitution rule applies under section 116-30 ITAA 1997 applies. And obviously, Jean says, an option to buy a property at a 50% discount has a significant value.
As it happens, you bump into Charles at a seminar not so long later and fall into discussion with him over a drink when it’s over. It isn’t pleasant for long, especially when the question of tax comes up. When it does, it’s obvious that Charles doesn’t know about the tax problem with the option. It is with exquisite pleasure that you tell him. And then go home.
Take away points
- Tax laws frequently change
- CGT exempt is different to income tax exempt
- Not all CGT events are exempt on a marriage breakdown
By Jim Main
This article is general information only and should not be relied on without obtaining further specific information.