Last Updated: June 17, 2022

Income Tax, Capital Gains Tax Marriage Breakdown Rollover Concession and Extracting Assets from Private Companies

Income Tax, Capital Gains Tax Marriage Breakdown Rollover Concession and Extracting Assets from Private Companies

It may have seemed like a simple decision at the time, to purchase a property (or other significant asset) within a private company. Where you operate a business from the company, this entity may have had the cash flow to support a property acquisition; or maybe you have a ‘bucket company’ receiving annual trust distributions, which was full of cash while still being separate from other, more risky assets, held elsewhere, and was the perfect entity to hold a property.

No doubt, you didn’t plan that yourself and your spouse would separate. But times have changed and you are currently reviewing all of your combined assets and working our who they should be allocated to. And one of the assets that you would like to retain (maybe the premises that are attached to a business that you will continue to operate, or any other specific asset), is held in a private company that your ex-spouse will wholly own after the separation.

What are the tax implications of extracting this asset?

Subdivision 126A of the Income Tax Assessment Act 1997 (ITAA 1997) provides capital gains tax (CGT) marriage breakdown rollover relief, where assets are transferred between spouses/ex-spouses as a result of a genuine marriage breakdown – this is where you have separated and there is no reasonable likelihood of resuming co-habitation.

Apart from the requirement for genuine separation, the parties must enter into one of the following acceptable agreements to qualify for the CGT marriage breakdown rollover concession – you are unable to simply access the rollover with an informal agreement between the two of you.

Acceptable agreements are (from section 126-5(1) ITAA 1997):

(a) a court order under the Family Law Act 1975 or under a State Law, Territory Law or foreign law relating to breakdowns of relationships between spouses; or

(b) a maintenance agreement approved by a court under section 87 of the Family Law Act 1975 or a corresponding agreement approved by a court under a corresponding foreign law; or

(d) something done under:

(i) a financial agreement made under PartVIIIA of the Family Law Act 1975 that is binding because of section 90G of that Act; or

(ii) a corresponding written agreement that is binding because of a corresponding foreign law; or

(da) something done under:

(i) a PartVIIIAB financial agreement (within the meaning of the Family Law Act 1975) that is binding because of section 90UJ of that Act; or

(ii) a corresponding written agreement that is binding because of a corresponding foreign law; or

(e) something done under:

(i) an award made in an arbitration referred to in section 13H of the Family Law Act 1975 ; or

(ii) a corresponding award made in an arbitration under a corresponding State law, Territory Law or foreign law; or

(f) something done under a written agreement:

(i) that is binding because of a State law, Territory law or foreign law relating to breakdowns of relationships between spouses; and

(ii) that, because of such a law, prevents a court making an order about matters to which the agreement applies, or that is inconsistent with the terms of the agreement in relation to those matters, unless the agreement is varied or set aside.

For many separating couples, completing the application process for financial Consent Orders under Section 79 of the Family Law Act 1975, and having these confirmed by the Federal Circuit and Family Court of Australia, will meet the acceptable agreement requirement. I will use the term ‘consent’ or ‘Court’ order to mean any acceptable type of agreement described above.

Prior to allocating assets to either party, you will have arranged for valuations of each individual asset – the original cost may not accurately represent the value of each asset in the pool. It may be that the current net market value significantly exceeds the original cost – the current value will be considered as part of the allocation process.

As part of the asset allocation, the Court also considers the tax impact on the transfer of the assets – this is very important from an equity perspective, as some assets like the family home may have no tax obligation when disposed of, but other assets, which have increased in value since the time of purchase, may have considerable latent capital gains tax liability to be paid on eventual disposal.

A ‘consent’ or other Court order, under section 79 of the Family Law Act 1975 (FLA 1975), the Family Court can require:

a private company, or
a party to the matrimonial proceedings to cause the private company,

to:

pay money, or
transfer property,

to a party to the ‘consent’ or other Court order.

Where an asset held by a private company is to be extracted and allocated to either yourself or your spouse as a result of your separation, please ensure that the private company is a party to the ‘consent’ order – the company is a separate legal entity and it’s inclusion in these documents is part of the ‘authority’ for the company to transfer the asset to a spouse/ex-spouse. It may also impact the transfer/stamp duty concession related to the transfer.

So, you have:

Determined market value of your family assets, including considering the current tax impost relating to each item;
Allocated the assets to each spouse;
Obtained your ‘consent’ or other acceptable Court order;
You are ready to physically reallocate assets currently within your family pool.

As a result, you may qualify to use the CGT marriage breakdown rollover concession.

What does this mean?

Utilizing the CGT marriage breakdown rollover concession means that there is no capital gains tax calculated on the change in ownership of these assets between spouses, and/or between private companies or trusts and the spouse/ex-spouse as a result of implementing your ‘consent’ orders. Note, the assets must be allocated to the individual spouses as transferees - there is no CGT marriage breakdown rollover concession available where the assets are transferred to a family trust or company as the transferee (although where a family trust or company is the transferor and the individual spouse is the transferee, that circumstance qualifies).

This rollover allows the transferee to retain the original purchase date and first element of the cost base of the asset, as it was in the hands of the transferor. Capital gains tax will not be payable on this asset until the eventual disposal of the asset by the person (transferee) receiving the asset as a result of implementing the ‘consent’ order.

This looks great so far… but there are additional rules where an asset owned by a private company is transferred to a spouse/ex-spouse in relation to the CGT marriage breakdown rollover concession, under Division 7A of the Income Tax Assessment Act 1936.

A summary of the outcome of the asset transfer from private company to individual is below:

While the asset may be held in the company’s financial statements at cost, it must be transferred to the spouse/ex-spouse at current market value;
The gain or loss is disregarded in the transferor company’s accounts;
The individual spouse/ex-spouse transferee receiving the asset receives a dividend from the company equal to the market value of the asset being transferred out of the company, less any consideration received by the company;
If there are sufficient franking credits in the company, the dividend may be fully franked, otherwise the dividend may be partially franked;
If the individual receiving the asset is a continuing shareholder in the company, the cost base of their shares is reduced by the value of the asset leaving the company and then will be increased by the amount included in their assessable income as a result of the asset that was transferred to this individual under the ‘consent’/Court order;
If the shareholder in the company is not the transferee of the asset, the cost base of the shareholders shares is reduced by their shareholding/portion of the market value of the asset leaving the company;
If a person who is not currently a shareholder of the company receives an asset as a result of acceptable ‘consent’ or other orders (as they are the spouse or ex-spouse and associate of a shareholder), they will receive a dividend per item (3) above as if they were a shareholder of the company.

Sounds simple?

Let’s look at the practical application of these rules.

Private Co Pty Ltd purchased a rental property 10 years ago for $300,000, and it is to be transferred to Spouse A as part of Court approved ‘consent’ orders. The property has more than doubled in value since acquisition (current market value $650,000), and there is no longer any debt associated with the property. Spouse A has not provided any consideration to the company for this asset. Assume the spouse/ex-spouse have met all requirements to access the CGT marriage breakdown rollover concession.

Eventhough the company holds this asset in it’s financial statements at $300,000, the value for the transfer to Spouse A is $650,000, as the amount of the payment (s109(3) ITAA 1997, which includes a transfer of property) must be as if it was on an arms length basis (market value), less any consideration provided for the asset (s109CA(10) ITAA 1936). The gain ($650,000 less the cost of $300,000 = $350,000) is disregarded from a tax perspective in the accounts of the company.

In this example, Spouse A will receive a net dividend of $650,000 from the company as the transferee. What does Spouse A’s tax position look like?

If there are sufficient franking credits, the dividend may be fully franked. If the company is not a ‘base rate entity’ and is paying tax at 30%, in this instance the franking credits will be $278,571, resulting in a total dividend to be included in Spouse A’s assessable income of $928,571.

Tax and Medicare on $928,571 (assuming no other income during the year) is $407,095, so after deducting the franking credit, Spouse A has a tax bill of $128,524.

If the company is a ‘base rate entity’ and the company is paying 25% tax, Spouse A has a worse tax position – while the lower franking credit of $216,666 reduces the total dividend to $866,666, and the tax payable on this amount is less at $378,000, the smaller franking credit results in the balance of tax payable for Spouse A being $161,333.

In some cases, there won’t be sufficient franking credits available to fully frank the dividend, and this may result in a partially franked dividend. Note, all dividends paid during the same financial year are to be franked at the same rate, so the directors may need to plan the timing of all dividends paid within the financial year of the property settlement to ensure sufficient franking credits are available to consistently frank dividends at the same rate during the year, to avoid the imposition of franking deficit tax.

For example, if a franked dividend has already been paid during the year (prior to a property settlement being envisaged), and there are insufficient franking credits available for the property settlement transfer dividend to be franked to the same extent, the company may have a franking deficit tax liability.

Insufficient franking credits may initially indicate that a company does not have a sufficient ‘distributable surplus’ to pay the dividend, but it may be that after accounting for the disposal of the asset at market value that this is rectified, as the company financial statements will reflect this gain.

Timing regarding the transfer of the property as a result of ‘consent’ orders and payment of any dividends during the same financial year will need to be carefully managed, where possible.

After the payment of the dividend and the resulting tax liability, what is Spouse A’s cost base for this asset? Under the CGT marriage breakdown rollover provisions, the transferee receives the original purchase date and cost of the asset they receive - $300,000.

So, while no physical consideration had to be paid for the acquisition of the asset, and you may have avoided paying the State Government transfer/stamp duty by accessing the rollover concession, Spouse A has a physical tax liability as a result of this transfer that should be taken into account by the Court when agreeing to the allocation of assets between the parties.

The amount of the dividend may be reduced where the transferee spouse has provided consideration for part/all of the purchase price, for example if there was debt on the property and the receiving spouse arranged for this to be paid out, or if other consideration was paid to the company for the transfer of this asset under the consent/Court order.

It is essential that any arrangement to provide consideration be included in the ‘consent’ orders sought. Where consideration is provided, any balance of the market value after the consideration paid is still subject to a dividend, with the franking credit issues identified above.

Not the best outcome… but knowledge is power – don’t be short changed on the allocation of assets by missing this important taxation liability at the time of agreeing to your share of the pool.

Michelle Wilson 6 June 2022