Marriage equals love and divorce
equals money
Basketballer Michael Jordan, movie stars Harrison Ford and Kevin Costner and
director Steven Spielberg have been named in Forbes magazine's top
10 most costly divorce settlements in Hollywood. Without a doubt,
their settlement documents were drafted by teams of lawyers ensuring
each matrimonial asset was dealt with accordingly and any taxation
minimised.
With the number of marriages expected to end in divorce at around one in
three, together with the increasing number of people choosing de
facto relationships, it is crucial to ensure that taxation advice is
obtained at the time of the property settlement.
Basic requirements
Subdivision 126-A of ITAA 1997 provides marriage breakdown rollover relief
where an individual (or a company or trust) disposes of an asset to
a spouse or former spouse as a consequence of:
-
a court order made under the Family Law
Act 1975; or
-
a court order under a state or territory law
relating to de facto marriage breakdowns; or
-
a maintenance agreement approved by a court
under a foreign law.
Rollover also applies to CGT events that happened after 12 December 2006
because of one of the following:
-
a financial agreement that is binding under
the Family Law Act 1975 ('binding financial
agreement'); or
-
an award made in an arbitration referred to
in the Family Law Act 1975 or a similar award under a
corresponding state or territory law ('arbitral award'); or
-
a written agreement that is binding because
of a state or territory law relating to de facto marriage
breakdowns and which, except to avoid injustice, cannot be
overridden by an order of a court.
Where the above requirements are satisfied, the rollover is automatic. As
a result, the parties cannot choose to apply the rollover or not
apply it (see also Taxation Determination TD 1999/60). Therefore,
capital losses cannot be crystallised by one party to, for example,
offset other gains the spouse has derived or may derive.
The rollover ensures that the spouse (or the company or trust)
transferring the asset is able to disregard a capital gain or
capital loss that would otherwise arise. The transferee spouse
assumes the transferor spouse's cost base and will derive the
capital gain or loss when they subsequently dispose of the asset.
The definition of spouse includes a person, who
although not legally married to the person, lives with the person on
a genuine domestic basis as the person's husband or wife. The AAT
recently held that the definition does not extend to same sex de
facto relationships: see The
Roll-over Relief Claimant and Commissioner of Taxation
[2006] AATA 728 (23 August 2006).
There are additional requirements to be met where the parties enter into
an arbitral award or a binding written agreement that cannot be
overridden by a court. In those instances the CGT event must be
directly connected with the breakdown of marriage or de facto
marriage, the spouses or former spouses involved must be separated
and there must be no reasonable likelihood of cohabitation being
resumed. For example, a transfer of property may not be directly
connected to the breakdown of marriage if the spouses had entered
into an agreement (such as a pre-nuptial or cohabitation agreement)
prior to the relationship breakdown.
If a couple is still on amicable terms and reaches an informal
agreement they will not be entitled to rollover relief. Accordingly,
the transferring party will be liable to pay CGT and if the other
spouse did not pay market value the market value substitution rule
will apply.
Example
Natasha and Steven have been living in a de facto relationship and own three
properties - the main residence, a beachfront holiday home worth
$575,000 and an investment property worth $350,000. They purchased
the holiday home for $200,000 and the investment property for
$200,000 several years ago. The holiday home has significantly
appreciated in value. The holiday home has many bad memories for
Natasha and they agree that she will take the investment property
and Steven will take the holiday home. They decide to sell the main
residence. Given the amicable separation they see no need in seeing
a family lawyer. In this case, the rollover provisions do not apply.
Natasha has received an asset worth $175,000 (the investment property) in
exchange for disposing of her interest in the holiday home that is
worth $287,500. As Natasha has received less than market value for
the holiday home the market value substitution provisions apply and
her gross capital gain is $187,500 ($287,500-$100,000). Applying
the 50% general discount would reduce the gain to $93,750.
Steven has actually received an asset worth $287,500 (the holiday home) in
consideration for transferring his interest in the investment
property that is only worth $175,000. Although Steven has received
more than market value for the investment property, the market value
substitution provisions apply and his gross capital gain is $75,000
($175,000-$100,000). Applying the 50% general discount his gain is
reduced to $37,500.
However, by seeing a family lawyer and having a relevant agreement drawn up,
tax on a combined net capital gain of $131,250 would have been
prevented.
Transfers by third parties
However, it is not only the property of the couple (and an associated company
or trust) that may form a part of a property settlement. The Family
Law Act 1975 was amended with effect from 18 December 2004, and
now contains provisions that allow the Family Court to direct a
third party to act in relation to the property of a party to the
marriage or alter the rights, liabilities or property interests of
the third party in relation to a marriage (refer to section 90AE of
the Family Law Act 1975). An order must be reasonably
necessary or reasonably appropriate to give effect to a division of
property that is just and equitable. The Court must take into
account the taxation effect of the order on the parties to the
marriage and on the third party.
This power is extremely wide and the impact of it being exercised is far
reaching. There is nothing to suggest that real property held in the
name of a third party could not be transferred to either spouse as
part of a property settlement. This results in an onerous obligation
and practically requires third parties to defend their position. To
date there have been no cases where the Family Court has exercised
this power, however, it is likely to be only a matter of time.
From
a tax perspective, rollover relief is not available to third
parties. Although the Family Court must take tax matters into
account, if a transfer of property is effected, someone must bear
the tax. It will be interesting to see whether the rollover
provisions will be extended even further to take into account third
party transfers.
Conclusion
The moral of the sad story of divorce and relationship breakdown is that
although it is no longer necessary to battle it out in the Family
Court in order to get the benefit of the marriage breakdown
rollover, it is still necessary to instruct a family lawyer to draft
an appropriate agreement. Accordingly, as tax advisors, referring
clients who are involved in marriage breakdown to family lawyers is
crucial to ensure the rollover is available.
This article appeared in Thomson's InTax
(June 2007); Australia's best independent monthly tax magazine. It
provides concise reports of the latest tax news, plus the practical
implications of tax developments in an easy-to-read magazine format.
To find out more, phone Thomson Customer Service on 1300 304 197 or click
here.
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