What are the Implications in Family Law Property Settlements of Divion 7A Loans?
Following the breakdown of a relationship, you will likely put your mind to the property you own or have accumulated during the relationship. A key concern for you may be how the property will be divided between you and your ex-partner, including Division 7A loans.
One of the most important steps in determining how to divide an asset pool in Family Law is to identify what the asset pool consists of and its value. This is often a point of dispute between parties who either do not agree with the figures or do not want certain assets or liabilities to be included. One difficulty where there is a company involved is shareholder or director loans, typically known as Division 7A loans.
What is Division 7A?
Division 7A is an anti-avoidance provision in the Income Tax Assessment Act 1936 (Cth). The primary aim is to prevent owners of private companies or their associates from withdrawing money from the companies they control as loans, rather than distributing the money as a wage or dividend, to avoid paying tax. In this context ‘associate’ has the meaning given to it in section 318 of the Income Tax Assessment Act, which can include for example a relative, partner, spouse, trustee of a trust, or a company. These “loans” became an issue as they would often be forgiven by the company, and neither the recipient of the money nor the company would incur the tax liability.
The main impact of Division 7A and Family Law is the ability to deem these payments between company and shareholder as a dividend, which effectively addressed a previously existing gap in the legislation. In particular, Division 7A treats the following payments by a private company as a dividend:
1. Amounts paid by the company to a shareholder or shareholder’s associate.
2. Amounts lent by the company to a shareholder or shareholder’s associate.
3. Debt owed by a shareholder or shareholders associate to the company that is forgiven.
As a result of this provision, a loan will only be viewed and treated as a loan if it is documented and repaid in line with a complying loan agreement. Where this is not the case, Division 7A can deem the payment a dividend which makes it assessable income of the shareholder or associate.
The interaction between the Income Tax Assessment Act and family law is complex and can carry significant tax consequences.
It is important to understand how Division 7A tax liability is dealt with in determining a balance sheet, and how certain Court Orders can attract the attention of Division 7A where the legislation is not properly considered. These situations are explored below:
Determining a Balance Sheet – Division 7A Loans and Family Law
One of the main cases in family law which considers Division 7A loans is Rodgers & Rodgers [2016] FAMCAFC 68, in which the Full Court looked at the impact of Division 7A liability when determining the balance sheet. In particular, the appeal considered whether the Primary Judge erred in refusing to deduct a calculation of the future tax payable by a company the parties controlled to determine the parties’ net asset pool.
In this case, money had been moved between the parties’ trust and the company which attracted the attention of Division 7A. Each party sought orders that the husband keep the business with the wife being removed and indemnified. The practical effect of this was that the husband would take on the Division 7A loans and any future tax liability, however as the liability had not yet occurred the parties could only provide estimate figures to the Court.
The Court considered the nature of a liability and how they can vary greatly, with some capable of being accurately assessed such as a mortgage and some which cannot be determined such as tax liabilities. After looking at the authorities, the Court found that while there might be a “rule” appropriate in most cases in which liabilities are deducted to determine the net asset pool, the way a particular liability should be treated depends on the nature, circumstances, and impact upon justice and equality. The Full Court agreed that the future tax liability, which could not be precisely determined in dollar figures, be excluded from the asset pool, and instead considered when determining an adjustment under section 75(2) of the Family Law Act 1975.
Court Orders attract the attention of Division 7A.
You also need to be aware of Division 7A when seeking Family Law orders from the Court to make sure you are not attracting tax liability. This occurred in the matter of Lacey & Lacey [2020] FamCAFC 73, in which the appeal considered whether the Primary Judge erred in making final Orders without evidence of the tax implications which would affect whether the orders were just and equitable. The final orders required the Husband to pay, or to cause to pay from the company, the sum of $2,980,639 to the wife. As the husband controlled the company and had a shareholding, the payment would trigger Division 7A as the wife is an associate. In this case, neither party provided evidence of the tax consequences which would flow from the orders they sought.
On appeal the Full Court found the likely Division 7A taxation liability for the wife would lessen her share from the property settlement. The matter was remitted for rehearing, however the Full Court commented that both parties were partially responsible for leading the Court into the error as neither had presented evidence of potential tax implications. This highlights the importance of being aware of the likely tax liabilities that will flow from the orders you seek from the Court.
As you can see, the intersection between Family Law and the Income Tax Assessment Act is complex, and Division 7A is an important consideration in determining the net asset pool and distribution of property settlements. If you find yourself in this situation, or you are going through a divorce or separation and have shareholder or director loans, it is important to remember these three things:
1. Surround yourself with professionals who can advise you on family law and taxation. Having an experienced and specialist family lawyer and accountant is an investment in yourself and allows you to know where you stand and regain control of your separation.
2. Be full and frank with your financial disclosure. As family lawyers we often refer to the phrase ‘full and frank’, but essentially it is about being upfront with your financial circumstances and providing the documents which detail this including bank accounts, loans or mortgages, credit cards, company financials, and superannuation.
3. Finally, make sure all loans are properly documented and repaid in accordance with the terms of a complying loan agreement.
Disclaimer:
It is essential for all parties to receive legal, financial and tax advice before finalising any property settlement and considering Division 7A Loans and Family Law. This will ensure that both parties walk away with what they have agreed to and also avoid nasty surprises down the track.
For more information:
Contact us on 02 8999 1800 or email info@cominoslawyers.com.au
You may also find the following pages/articles of interest:
Property and Financial Settlements