Family Law - The end of Division 7A exemptions on matrimonial property settlements

In August 2014, the ATO released Taxation Ruling 2014/5. This ruling confirmed that the payment of money or transfer of property from the profits of a private company on the basis of a Family Court order under section 79 of the Family Law Act 1975 (Cth) gives rise to a Division 7A dividend being paid from the company to the recipient spouse. This results in the recipient spouse being liable to pay income tax at personal rates on the amount which he or she receives.

The Ruling provides:

Ordinary Dividend: That if the payment of money or transfer of property is made to a recipient spouse who is a shareholder of the private company, such payment of money or transfer of property will be considered an ordinary dividend paid out of the private company’s profits (if any). The recipient spouse includes that payment in his or her assessable income.

Deemed Dividend: If the recipient spouse is not a shareholder, he or she will be deemed an associate (of a shareholder) and taxed on the cash or property as a deemed dividend under Division 7A (the fact that a couple have separated does not preclude them from being ‘associates’ for Division 7A purposes). The recipient spouse includes that payment is his or her assessable income.

Prior to the release of TR 2014/5 it was common practice for parties to a matrimonial settlement to rely on the exemption under Section 109J of the Income Tax Assessment Act 1936 (Cth) which enabled them to avoid Division 7A consequences if the payment or transfer was pursuant the terms of a section 79 Family Court order to a spouse who is not a shareholder. This exemption is no longer possible where the obligation to pay the money or transfer the property was imposed by the Court on or after 30 July 2014.

Example:

Glenn and Rosanne are parties to matrimonial property proceedings before the Family Court. Rosanne is the sole shareholder/director of G & R Pty Ltd which is the vehicle for her business and has retained profits of $200,000 and the distributable surplus of G & R Pty Ltd is $100,000. G & R Pty Ltd is not a party to the proceedings.
As part of the proceedings, the Family Court makes a section 79 order for Rosanne to cause G & R Pty Ltd to pay $100,000 to Glenn.
The payment to Glenn is treated as a dividend as defined in Section 109C(3)(a) of the Income Tax Assessment Act 1936.
Section 109J of the Income Tax Assessment Act 1936 does not prevent Section 109C operating to treat the payment of money as a deemed dividend.
The payment of $100,000 is assessable to Glenn as a dividend under section 44 of the Income Tax Assessment Act 1936, by virtue of section 109C of the Income Tax Assessment Act 1936.

Where to?

Given the Commissioner’s view under TR 2014/5 it is important to ensure that in your negotiations to a matrimonial settlement, due attention is given to this issue to ensure that the tax consequences are minimised so that the result for the client is not reduced by the impact of the ruling.