The Difference between Hacking & Carving

(1)

Tax issues in

Family Law

The Difference between

Hacking & Carving

by

Peter Szabo

Marshalls & Dent Melbourne

(2)

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.

(3)

The Split - Hacking

Husband Wife Revenue

(4)

The Split - Carving

Husband Wife Revenue Advisers

(5)

Investment Potential

over years

0 100 200 300 400 500 600 700 800

Husband Wife

(6)

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

(7)

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.

(8)

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?

(9)

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.

(10)

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 companies

As long as one party is a beneficiary, the Family

Court can bring that entitlement into account. The

key issue is who

controls

the resource.

(11)

Apportioning the Assets

Real Estate

• Stamp Duty

Transfers 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

(12)

Example 1 - CGT on Investment

Property

Husband Tax = $12,500

at marginal rate of tax say 50%

Wife

Tax = $12,500

at marginal rate say 50%

Capital gain on jointly Owned Inestment property

$100,000

Amount subject to CGT

$50,000 after Ralph = $25,000 each

Both parties on same tax rate so pay the same tax Total tax payable is $25,000

(13)

Example 2 - CGT - different tax rates

Husband = $25,000 Tax = $12,500

at marginal rate of tax say 50%

Wife = $25,000 Tax = $7,000

at marginal rates average say 25% Profit on sale of Jointly Owned Investment property

$100,000

Each to equally share gain - $50,000 taxed after Ralph

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

(14)

Example 3 - CGT transfer to spouse

Husband = Nil Tax = NIL

Transferred to Wife Rollover applicable

Wife = $50,000 Tax = $16,000

at marginal rates Solely Owned Investment property

$100,000

Husband fully liable at top rate would pay $25,000

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

(15)

Example 4 - impact of Capital losses

Husband = $100,000 Tax = NIL

Capital losses used

Wife = $Nil Tax = Nil

at marginal rate Jointly Owned Investment property

$100,000

Amount subject to CGT Each to equally share gain

Asset transferred to Husband with capital losses Duty free transfer

(16)

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

(17)

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

(18)

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

(19)

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

(20)

Divorcing the Discretionary Trust

• 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

(21)

Divorcing the Discretionary Trust

Disengaging control involves :

• Resignation as appointor/guardian

• transferring shares in trustee company

• resignation as director of trustee company

• exclusion from being a beneficiary

Where there are losses - watch continuity of control if no family trust election

(22)

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

(23)

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?

(24)

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.

(25)

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

(26)

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.

(27)

Retaining Carried

forward Losses in a

Company

The 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

(28)

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