Marshalls & Dent Lawyers Tax issues in Family Law The Difference between Hacking & Carving...

Marshalls & Dent Lawyers

Tax issues inFamily Law

The Difference between

Hacking & Carvingby

Peter SzaboMarshalls & Dent

Melbourne03 96705000

pszabo@mdlaw.com.au

Forced Estate Planning

• Assets must be apportioned between the parties, often with unwanted taxation consequences.

• Emotional issues a “wild card”

• By destroying an asset of one party, the total pool of available assets to be split between both parties is diminished.

The Split - Hacking

HusbandWifeRevenue

The Split - Carving

HusbandWifeRevenueAdvisers

Investment Potential over years

1st Year 2nd Year 3rd Year 4th Year 5th Year

HusbandWife

What are the Net Assets?

• The Form 17 Financial Statement

Take into account assets net of tax, contingent liabilities.

• Impact of tax changes - Ralph report, GST

• The Hidden Agenda - Tax evasion issues

What are the Net Assets?

• The relevance of CGT - In placing a value on an asset, is CGT taken into account?

Not necessarily!

• Income Tax -Any tax incurred by either party is a relevant debt to be taken into account. Similarly, any taxation refund is an asset also to be taken into account.

Superannuation

• Dividing up superannuation assets -A financial resource which will become available to one of the parties at some later stage. It must be taken into account in some way.

• Changing approach to Superannuation. The approach in many cases is to give one party more of the assets and let the other party keep the superannuation asset. But is that fair in the current economic climate?

Superannuation

• A mathematical approach preferred. A trend has been to take into account the years of marriage against the total years in the fund, and adjust for that proportion.

• Proposed changes to Family Law Act

Presumption will be that the contributions relevant to the period of the marriage are to be apportioned equally - but

retained until retirement.

Other Financial Resources

• Interests in trusts and companies -These are often treated as the ultimate assets of the parties by the Family Court - but not always. The facts of each particular case is important.

• Valuing interests in trusts and companiesAs long as one party is a beneficiary, the Family Court can bring that entitlement into account. The key issue is who controls the resource.

Apportioning the Assets Real Estate

• Stamp DutyTransfers of otherwise dutiable assets are almost always exempt from duty when transferred between spouses as a

result of a separation.

• Rollover relief - Court orders or S87 Agreements only

Main residence exemption • Minimising CGT on a sale

Example 1 - CGT on Investment Property

H usbandTax = $12,500a t m arg in a l ra te o f tax

say 5 0 %

W ifeTax = $12,500

a t m arg in a l ra tesay 5 0 %

C ap ita l g a in on jo in tly O w n ed In es tm en t p rop erty

$100,000A m ou n t su b jec t to C G T

$ 5 0 ,0 0 0 a fte r R a lp h = $ 2 5 ,0 0 0 each

Both parties on same tax rate so pay the same tax

Total tax payable is $25,000Net asset $75,000

Example 2 - CGT - different tax rates

H usband = $25,000Tax = $12,500a t m arg in a l ra te o f tax

say 5 0 %

W ife = $25,000Tax = $7,000

a t m arg in a l ra tesaverag e say 2 5 %

P ro fit on sa le o f Jo in tly O w n ed In ves tm en t p rop erty

E ach to eq u a lly sh are g a in - $ 5 0 ,0 0 0 taxed a fte r R a lp h

Different Tax for one party - less tax payableTotal Tax Payable = $19,500

Net Asset = $80,500

Example 3 - CGT transfer to spouse

H usband = N ilTax = N IL

Tran s fe rred to W ifeR o llover ap p licab le

W ife = $50,000Tax = $16,000

a t m arg in a l ra tes

S o le ly O w n ed In ves tm en t p rop erty

H u sb an d fu lly liab le a t top ra te w ou ld p ay $ 2 5 ,0 0 0

Asset transferred to Wife and THEN sold Rollover relief, duty free transfer to wife

Total Tax Payable = $16,000Net Asset = $84,000

Example 4 - impact of Capital losses

H usband = $100,000Tax = N IL

C ap ita l losses u sed

W ife = $N ilTax = N il

at m arg in a l ra te

Jo in tly O w n ed In ves tm en t p rop erty

E ach to eq u a lly sh are g a in

Asset transferred to Husband with capital losses Duty free transfer

Total Tax Payable = NilNet Asset = $100,000

Capitalising delayed payments

• Pay $100,000 in 12 months, with interest, at what rate - 11.3% current rate.

• Pay $111,300 in 12 months time - capitalised, no tax consequences to payee

• Haggle over the capitalised amount - eg - pay $107,000 in 12 months as a capital payment. Both parties better off

Cost Base of acquired property may include family

law costs

• Property valuations - 100%• Accounting fees - possibly 100%• Proportion of total Family Law costs relevant to

property proceedings• These may be taken in proportion to the total

assets kept - eg if CGT asset is 50% of asset pool, 50% of above costs is included in costs base

Divorcing the Partnership

• Apportioning the income stream. Is there any flexibility? One person controls that stream, the other gets “maintenance” . Who pays what tax?

• Capital assets and trading stock Watch rollover relief as elections are possible.

• Indemnities with partnerships - Need to

cover any contingencies, particularly tax.

Divorcing the Discretionary Trust

Specific Tax issues involve:

• Loss Trust Legislation• Election to become a Family Trust needed for

Franking credits, trust losses• Test individual important - where possible

choose one of the children to retain distribution potential to spouses

• The income stream - Distributions post separation may be tax effective even after divorce.

• Dealing with the assets of the trust Real Estate duty free, rollover relief for CGT

• Loan accounts - Watch debt forgiveness issues. Are they loans or beneficial entitlements?

Disengaging control involves :• Resignation as appointor/guardian• transferring shares in trustee company• resignation as director of trustee company• exclusion from being a beneficiaryWhere there are losses - watch continuity of control if no

family trust election

Consequences of Poor Family Trust election

• No opportunity to effect spousal maintenance payments tax effectively out of the trust.

• No opportunity to pass control of the trust to spouse as part of a settlement

• Value of trust asset as tax planning vehicle diminished

Divorcing Spouse from Company

• The income stream - make tax effective adjustments where possible.

• Transfers of assets from the company Real estate usually subject to stamp duty

• CGT rollover relief available sometimes - but is the transfer a deemed dividend?

Divorcing the Company

• Companies with losses - Continuity of ownership test relevant to carry forward losses

• Debt forgiveness/deemed dividend issues

Dealing with loan accounts needs particular attention to avoid unwanted revenue issues. FBT issues can arise if the spouse is an empoyee.

Divorcing the Company

Disengaging a spouse may involve:• Resignation as director• Transferring shares• retiring as an employee

Retiring spouse needs tax indemnities

• remaining spouse should be aware of tax liabilities being covered

• GST - vendor pays but is this right?

Other Aspects to Consider

• Impact on third parties - Change in shareholding may “freshen up” assets for CGT purposes. FBT, loss of cost base and inability to use deductions and other losses.

• Accounting issues - timing of disengagement may necessitate account keeping changes. Try to coordinate these to financial years.

• Tax issues with spousal maintenance. Consider trust distributions, but watch “Family trust” election. Termination packages for employee spouse.

Retaining Carried forward Losses in a

CompanyThe problem is not to fail the continuity of

ownership test - otherwise harder tests to pass to satisfy ATAO

• Solution 1 - retain shareholding• Solution 2 - delay transfer of shareholding

until losses used• Solution 3 - Issue more shares and leave

exiting spouse with a share

Advance Planning

Tax planning structures need flexibility

• Awareness of consequences of family breakdown will alert the financial adviser or

estate planner to some preventative measures. • eg - if company involves husband and wife,

issue more than 2 shares if you MUST have both spouses involved

Advance Planning Other strategies

• Carefully consider the choice of controllers of the trading entity

• Consider alternatives to giving external parties equity and control

• Prepare shareholders’ and other business agreements in anticipation of disputes

• Consider pre-nuptial agreements

Financial Agreements

• CGT Time bomb - no rollover relief for transfers of property

• Bankruptcy protection may be available

Tax issues inFamily Law

The Difference between

Hacking & Carvingby

Peter SzaboMarshalls & Dent

Melbourne03 96705000

pszabo@mdlaw.com.au

Marshalls & Dent Lawyers Tax issues in Family Law The Difference between Hacking & Carving...

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