How divorce can cause a messy split in your business
Divorce statistics don’t make for great reading. One in three first marriages and one in two second marriages end in divorce.
Assuming the statistics are reasonably consistent across the small business community then it is likely that a large number of SMEs will be caught up in family law property settlements.
These settlements are simply about causing a division of assets of the marriage. And that includes the business assets.
Either by agreement or as part of the division it is common for assets owned by the business to be transferred out of the business to one of the parties.
This can achieve the property split but are there are tax issues that come with this transfer?
There are three key tax risks to consider – capital gains tax, Division 7A, and GST.
Where a capital asset is transferred out of a company or trust this can give rise to a capital gain. This is despite the fact that all of the parties may not be in favour of the transfer and simply following a decision of the Family court.
Subdivision 126-A of the Tax Act provides relief for such a transfer providing it is done under a court order under the Family Law Act or a binding financial agreement.
In this case there is relief from any capital gain. It is important in these cases to ensure that all of the conditions are met.
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Even where the parties reach amicable settlement terms they should be formalised under an order of the court. The lack of this formality will cause you to lose the tax relief.
Whilst this should save you from any capital gains tax liability the transfer of the asset out of the company can trigger Division 7A of the Tax Act.
This section captures payments to or on behalf of a shareholder of the company where they are not otherwise taxed.
Your accountant may have warned you about problems with shareholder loan accounts. These are a part of the same provisions.
Where the transfer of the asset out of the company triggers Division 7A this will result in a deemed dividend being paid under section 109C.
The provisions do allow this dividend to be franked which will lessen the tax impact but it can still result in an unpleasant tax outcome.
The last issue to keep in mind is the GST effect on assets transferred out of a GST registered entity.
Whilst this transfer is not counted as a taxable supply for GST purposes, where it is transferred by a business to an individual for private use then Division 129 of the GST causes an adjustment which will require some of the input tax credits claimed when the asset was originally purchased to be paid back to the Tax Office.
Divorce causes enough stresses without unexpected tax problems. If you are approaching a property settlement make sure you get some tax advice in advance of agreeing the final division of assets.
Greg Hayes is a director of Hayes Knight and specialises in taxation and business planning advice.