Going through a divorce is a difficult time emotionally, and it can be overwhelming to also try to handle the financial aspects involved. So this is what we broadly take you through below.
Divorce & Relationship Breakdowns - Tax Matters
Given that in Australia roughly one in three marriages now end in divorce, there is a good chance that many Australians will be impacted either directly or indirectly by a divorce at some stage in life.
In any divorce or relationship breakdown situation it is critical to understand the potential tax implications, as this will impact the overall value of the pool of assets in question.
Capital Gains Tax
Generally, capital gains tax (CGT) applies to any change of ownership of an asset.
However, roll-over relief automatically applies in certain cases involving the transfer of assets as a result of the breakdown of a marriage or a relationship. Roll-over relief allows a taxpayer to disregard the capital gain or loss until another CGT event happens (e.g. when the asset is later sold).
The full list of instances where the roll-over applies is detailed in Sect 126.5 of the Income Tax Assessment Act 1997 and includes where a court order or a financial agreement is made under the Family Law Act 1975 (or equivalent state law). It does not apply to informal or private arrangements.
The roll-over applies to CGT events A1 and B1 (disposing of assets) and D1, D2, D3 and F1 (creation of assets).
Any capital gain or loss the transferor makes from the CGT event is disregarded, and the transferee essentially inherits the cost base of the asset at the time of the transfer. There are also special rules regarding indexation and the main residence exemption.
Transfers from Private Companies
In divorce property proceedings, under Sect 79 of the Family Law Act 1975 the court can order a private company to pay money or transfer property to one of the parties.
ATO ruling TR 2014/5 deals with the income tax consequences of Sect 79 orders, and confirms their view that a transfer of money or property from a private company:
- to a shareholder – is an ordinary assessable dividend to the extent it is paid out of profits; or
- to an associate of a shareholder – is a deemed dividend for Division 7A purposes; and
- in either case may be franked at the discretion of the company subject to the usual franking rules.
Such a payment would be included in the taxable income of the recipient and taxed at their marginal tax rate (less any franking credit). Therefore a transfer of assets held by a company may be less tax efficient than a transfer of assets held elsewhere.
Divorce & Superannuation Splitting
In some circumstances, superannuation interests may be split as part of the division of property following divorce.
Super agreements and court orders specify how a member's super interest in the fund, or how a super payment, will be split between the member and their spouse. This may result in a new super interest being created for a spouse within the members fund, or be transferred to another fund in the spouse’s name.
Practically, as a Self-Managed Superannuation Fund (SMSF) is run by its members as Trustees (or Directors of the corporate trustee), administering the fund on a day-to-day basis may get difficult where relationships are strained and communication breaks down. This would also often lead to a member exiting a fund.
Where this occurs, there may be significant implications to the fund and its investments. It may be necessary to sell off investments to raise the necessary cash to roll out benefits – this could be problematic in some cases, for example, where an SMSF owns the premises of the family business.
While CGT rollover applies where assets representing a member’s interest are directly transferred from one fund to another as a result of a family court order, this does not apply where the assets are simply sold by the fund, even if the purpose of the sale is to raise cash to satisfy a payment under a splitting order.
Going through a divorce is a difficult time emotionally, and it can be overwhelming to also try to handle the financial aspects involved. If you are involved in a situation like this and would like some advice or assistance, please get in touch with us online or by calling (02) 4229 2211 today and one of our advisers will be able to help you.