The effect of Capital Gains Tax in Family Law Proceedings

Family Law: 04 December 2020

When parties to a marriage or a de facto relationship separate and adjust property interests between them they will either retain, sell, transfer or otherwise dispose of assets they have accumulated during their marriage. As a result, taxation issues can arise in many family law settlements. Family lawyers need to be aware of any potential taxation implications of property settlements and, in appropriate cases, factor this into the split.

The most common taxation issue which arises in family law settlements is capital gains tax, referred to in the Income Tax Assessment Act 1977 (the ITAA).

Capital Gains Tax

Capital Gains Tax (CGT) is a tax payable pursuant to the ITAA on the disposal of an asset that had been purchased after 20 September 1985. This includes the sale, transfer or disposal of that asset to another person or entity. The tax is applied to the profit that is made from such sale, transfer or disposal. It applies to all assets but there are important exceptions which include:

• The parties' main residence (i.e. the former matrimonial home);
• Motor Vehicles;
• Personal Assets acquired for less than $10,000.00 (furniture and chattels); and
• Collectables (art, antiques etc) to the value of less than $500.00.

When there is an adjustment of property between parties to a marriage or a de facto relationship, this may give rise to a CGT event when it involves the sale, transfer or disposal of an asset.

The former Matrimonial Home

As discussed above, if the former matrimonial home has been the main residence of the parties then regardless of whether it is sold, transferred or disposed of, it will not attract CGT as it one of the exceptions under the ITAA. The situation may be different if there has been a period of time where the property was not the main residence of the parties. For example, if the property is rented out as an investment property for a period of time before the parties commence to live in it as their main residence. In such situations a sale, transfer or disposal may attract CGT but the assessment will be restricted to the time period when it was not the main residence.

Investment Property

If an investment property or any other non-exempt asset, is sold as a result of a family law property settlement, then CGT will be assessable on the profit from the sale. If the property is in joint names of the parties then both will be assessed to pay CGT on their share of the profit. If the property is in the name of only one of the parties then that party will be assessed to pay the tax. Similar considerations apply when the asset is held by an entity controlled by one or both of the parties. It is therefore important that any property settlement considers the payment of any CGT on the sale of an asset.

There are discounts that may apply to reduce the 'profit' and therefore the tax that is assessed to be paid. These should be carefully identified and evidenced.

CGT rollover relief

In a situation where an asset that is not exempt from CGT is transferred from one party to another (rather than sold) then normally CGT would apply to the transfer. If, however, the asset is transferred as the result of a breakdown of a relationship then there is provision in Section 126 of the ITAA for what is called rollover relief upon the transfer.

Rollover relief means that upon the transfer CGT can be disregarded until such time as the party receiving the asset sells it, transfers it or otherwise disposes of it. For example, if an investment property is transferred to a party after the breakdown of a relationship there is no capital gains tax payable at that time. However if that party subsequently sells or transfers the property, they will be liable for CGT on the later sale. The cost base of the asset is also transferred to the party receiving the asset.

Rollover relief only applies if:

• If the asset is transferred between the parties to a marriage or a de facto relationship or from a company or a trust to one of the parties; and
• The transfer is made as the result of a court order or a binding financial agreement.

Will CGT be included in the property pool?

The leading authority on the issue of CGT is the case of Rosati and Rosati [1998] FamCA 38, where the Full Court laid out the following principles:

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 midterm, 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.€ Whether CGT will be taken into account in calculating the net asset pool will depend upon the circumstances of that individual case.

Conclusion

When finalising family law property settlements, the following are important:

1. Family Lawyers should have knowledge of the tax implications of a settlement;
2. Orders need to be drafted correctly to consider any potential taxation liabilities; and
3. In some matters, more complex taxation advice may be required.