Following the breakdown of a relationship, it is common for parties to enter into a property settlement with respect the division of their assets.
However, in family law property matters, parties often overlook the consequence or potential consequence of selling an asset that is part of the matrimonial pool of assets available for distribution.
One of these consequences is the potential impact Capital Gains Tax will have on the outcome of their matter.
For example, it is not uncommon in family law matters for there to be a sale or transfer of an asset as a property settlement which may attract Capital Gains Tax.
What is Capital Gains Tax?
Capital Gains Tax (CGT) is a federal tax that is governed under the Income Tax Assessment Act 1997.
CGT is payable on the capital gain (i.e. profit) made from the sale, exchange, or transfer of assets following 20 September 1985.
CGT is not a separate type of tax, but merely a form of income tax in which you are required to declare in your annual income tax return.
The CGT is paid when a CGT event occurs.
What is a CGT Event?
A CGT event marks the point in time at which you make a capital gain or incur a capital loss when you sell an asset that is subject to CGT.
However, it is important to note that you need to know the type of CGT event that applies in your situation as it may affect how to calculate your capital gain or your capital loss and when the CGT event happens.
The most common CGT event that occurs is when someone sells an asset to someone else or to another entity.
However, it is also important to note that CGT events also occur to events including but not limited to:
(a) You have lost or destroyed and asset you own (whether intentionally or unintentionally).
(b) You have cancelled, surrendered or redeemed shares you own.
(c) You receive a payment (not a dividend) as a shareholder from a company.
Timing of CGT event
With respect to a CGT event, it is imperative to note the timing that the event occurred as this will determine which financial year you report the capital gain or loss.
If you sell an asset such as land, then the CGT event will be the time the contract has been entered into. For example, if you are selling a piece of land, the CGT event will occur at the time of exchange, and not at the time of settlement.
Where there is a loss or destruction of an asset, the CGT event occurs when compensation is first received or, if none, when loss discovered or destruction occurred
Example (sale of asset):
On 1 January 2022, Tom purchased a vacant piece of land for $400,000. On 29 May 2022, Tom enters into a contract for sale to sell his vacant piece of land for $700,000. Settlement occurred 42 days later on 10 July 2022. In this case, the CGT event occurred in the 2021/2022 financial year, being the financial year in which Tom entered the contract for sale and made a capital gain, and not the 2022/2023 financial year in which settlement occurred.
What assets incur CGT?
Assets that are subject to CGT include the following three categories of assets
Collectables include but are not limited to:
(a) Artwork such as painting.
2. Personal use assets
Personal use assets include but are not limited to:
(c) Electrical items.
(d) Household items.
3. Other assets
Assets that are not considered as collectables or personal use assets include but are not limited to:
(a) Vacant land.
(b) Investment/rental properties.
(c) Shares in a company.
(d) Units in a unit trust.
What assets are exempt from CGT?
Assets that are exempt from CGT include but are not limited to the following:
1. Assets acquired before 20 September 1985.
2. Family home (i.e. your principal place of residence).
3. Cars and motorcycles.
4. Collectables less than $500.
5. Personal use assets less than $10,000.
With respect to your principal place of residence, CGT may be applicable if:
(a) You decide to rent it.
(b) You use it for a business.
(c) It is on more than 2 hectares of land.
How is CGT treated in Family Law Property Settlements?
In family law matters, it is not uncommon where an asset that is not exempt from the payment of CGT, is transferred from one spouse to the other following the breakdown of their relationship.
Pursuant to section 126.5 of the Income Tax Assessment Act 1997, where there is a breakdown of a relationship whether two people have separated or divorced, there is a roll over relief if a CGT event occurred.
This means that that the CGT will defer (i.e rollover) and that the CGT is not payable by the party receiving the asset at the time of the transfer however it will be payable by the party who received the asset when that party subsequently sells or transfers the asset.
Pursuant to s126.5 of the Income Tax Assessment Act 1997, it is important to note the following with respect to rollover relief:
1. The rollover relief only applies in circumstances including any of the following:
(a) There is a court order under the Family Law Act 1975 or a state, territory or foreign law relating to relationship breakdowns.
(b) The is a maintenance agreement that has been approved by a Court under section 87 of the Family Law Act 1975.
(c) A financial agreement that is binding under the Family Law Act 1975.
(d) A written agreement that is binding because of State law, Territory law or foreign law relating to breakdowns of relationships between spouses hat, 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.
(e) An award made in an arbitration referred to in section 13H Family Law Act or a similar award under a state, territory or foreign law.
2. The rollover relief applies to the following CGT events where one spouse:
(a) Transfers the CGT asset from to the other.
(b) Enters into an agreement where the right to use and enjoy a CGT asset passes to the other spouse at the end of the agreement.
(c) Creates a contractual or other right in favour of the other spouse.
(d) Grants an option to the other spouse or renews/extends an option granted to them.
(e) Owns a prospecting or mining entitlement and grants the other spouse a right to income from the mining or prospecting.
(f) Grants, renews or extends a lease to the other spouse.
3. There is no rollover relief for transfer of trading stock.
When does the Family Court Consider Capital Gains Tax
There is a degree of confusion with respect to whether the Court should consider the effect of potential CGT, (which would be payable upon the sale of an asset) when calculating the available property pool to be divided between the parties.
One of the most frequently quoted cases with respect to the consideration of CGT is the case of Rosati v Rosati (1998) FamCA 38.
In this case, the Court established, following general principles, quoted verbatim:
(1) Whether the incidence of capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
(2) If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
(3) If none of the circumstances referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to mid-term, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s.75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
(4) There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.
In the 2021 case of Taffner v Taffner  FamCAFC 68, the Full Court of the Family Court of Australia considered the treatment of CGT liability incurred upon the sale of property.
In this case, this was an appeal by the Husband against a suite of final property settlement orders made by the primary judge in August 2020 in proceeding between the Husband and the Wife. The primary judge in this case held that it was just and equitable for the parties property to be divided to effect an overall distribution of 60.63% to the Wife and the balance of 39.37 % to the Husband. To give effect to the division, the following orders were made:
1. The Wife was to retain a property she owned and to become the sole owner of a jointly owned property, and that the parties were to refinance the joint property so that the Husband and Wife be released from any obligations under the mortgage that encumbered it.
2. If the parties were unable to refinance the joint property that the Wife was to retain, then the joint property was to be sold.
3. Superannuation splitting orders.
4. The husband was to retain a property in his name and was thereafter to be refinanced removing the Wife from the mortgage. If the Husband could not achieve this, then the husband’s property was to be sold.
5. Orders relating to retention sundry chattels and bank accounts.
The Full Court of the Family Court of Australia was asked to consider whether the primary judge has erred in judgment as the Husband had asserted that there was a lack of procedural fairness in the making of the orders relating to the Husband’s property, namely, that neither the Husband or the Wife sought Orders an Order that it be retained by the Husband and the primary Judge did not raise with the parties that there may be a possibility of such an order being made, or make any consideration of a possible CGT liability in the event the Husband was required to sell the property.
The Husband further argued that the Order that he retain the property solely owned by him,
“cast the burden of capital gains tax of that property solely on him, with the effect that the actual division of property was 65.87 per cent to the wife rather than the 60.63 per cent that had been assessed by the primary judge” .
The Husband unfortunately in this case was unable to refinance his property and had to sell the property after the Final orders made in 2020. The appeal was allowed with regards the issue of the treatment of the CGT liability incurred by the husband upon the sale of his property, to provide for a re-exercise of the Courts discretion to take into account the CGT liability that the Husband had incurred.
It is essential for all parties to receive legal, financial and tax advice before finalising any property settlement. This will ensure that both parties walk away with what they have agreed to and also avoid nasty surprises down the track.
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