Matrimonial Property Settlements – Navigating the Tax and Duty Traps

Separating from a spouse or de facto partner is often a challenging and emotionally difficult time. The process can be further complicated by the need to consider financial implications including potential income tax, capital gains tax and stamp duty consequences as part of the matrimonial property settlement.

The way in which assets are owned and transferred can materially affect the tax outcome for both parties. This article examines several key taxation and Victorian duty considerations that separating couples (and their tax advisors) should be aware of when structuring matrimonial property settlement.

Capital gains tax rollover relief

In the absence of any CGT rollover reliefs, concessions or exemptions, the division of assets as part of a matrimonial property settlement could potentially trigger significant capital gains tax liability for the transferring party. This creates a practical issue as matrimonial property settlements will often involve assets being transferred for no, or less than market value consideration. The transferor spouse may therefore face a tax liability without receiving sufficient cash proceeds from the transaction to fund that liability.

Fortunately, this issue can be addressed where the division of assets under a matrimonial property settlement qualify for the CGT rollover relief under Subdivision 126-A of the ITAA 1997. Broadly, the rollover can apply where the CGT asset that is the subject of the matrimonial property settlement is transferred from one spouse/former spouse to the other pursuant to one of the prescribed arrangements such as a court order or binding financial agreement made under the Family Law Act 1975. The rollover can be extended to assets owned by an entity such as a company or trust, provided the recipient is the spouse/former spouse (being the other party to the arrangement), and the asset transferred is made because of, or in compliance with, one of the statutory prescribed arrangements.

Where the Subdivision 126-A rollover applies, any capital gain or capital loss arising to the transferor is disregarded. The recipient spouse inherits the transferor’s cost base or reduced cost base of the CGT asset transferred. Any unrealised CGT liability is therefore, effectively also transferred to the recipient spouse and is deferred until a subsequent CGT event occurs in relation to the subject CGT asset.

Does Division 7A matter?

The availability of the Subdivision 126-A rollover relief does not necessary eliminate other potential tax risks, one being Division 7A, particularly where a private company owns the CGT asset that is the subject of the matrimonial property settlement, and the transfer occurs for no or less than market value consideration. Although a Division 7A dividend arising in connection with family law obligation is frankable, the recipient spouse may nevertheless have an income tax liability in respect of the deemed dividend which arises in relation to the asset transfer. Accordingly, any potential Division 7A exposure should be identified and factored into the negotiations when determining the respective entitlements of the separating couples.

What about Trusts?

A further complication may involve situations where ownership or control of a trust is changed (instead of the trust assets being transferred).  In such situations it becomes relevant to know if that trust has any family trust or interposed entity elections and whether, post separation, the ex-spouse is within the trust’s family group.

Victoria Duty

Generally, a transfer of dutiable property including real property, and certain interests in landholding entities, will attract duty unless a specific statutory exemption or concession applies. Each State and Territory has its own rules governing transfers between spouses or former spouses arising from the breakdown of a marriage or domestic relationship.

In Victoria, a transfer of dutiable property between spouses as part of a matrimonial property settlement will generally qualify for duty exemption where the relevant statutory requirements under section 44(1) of the Duties Act 2000 (Victoria) are satisfied and the dutiable property ultimately ends up solely owned by the spouse/former spouse receiving it.

However,  the section 44 duty exemption becomes more complicated where the property (being the subject of the matrimonial property settlement) is held through a trust or a company .

Trust Ownership

Where the dutiable property being the subject of the matrimonial settlement is owned by a trust, one of the qualifying conditions is that the trustee must be “…a trust of which the party (or both parties) to the marriage/domestic relationship is a beneficiary” (the ‘transferor condition’).

The transferor condition could arguably be satisfied where the dutiable property is owned by a discretionary trust, and the wife, husband (or both) are included within the class of beneficiaries specified in the trust deed.

However, a more difficult issue arises where the property is owned by a unit trust. Consider a relatively common structure:

• the real property is owned by a unit trust;
• neither the husband or wife is a unitholder of the unit trust; and
• all the units in the unit trust are instead owned by a discretionary trust.

The question then becomes whether the husband or wife (or both) who are merely within the beneficiary class of the discretionary trust unitholder can satisfy the ‘beneficiary’ requirement of the transferor condition.

The term ‘beneficiary’ is not defined in section 44.  In a typical unit trust, the beneficiaries would generally be expected to be the unitholders. The wording of section 44(1) – requiring the relevant transferor to be ‘a trustee of a trust of which a party to the marriage is a beneficiary’, arguably suggests that the provision does not contemplate a ‘look-through’ approach whereby persons (other than the unitholders) are treated as beneficiaries of a unit trust. This may give rise to the potential risk of a duty exemption not being available where the relevant spouse is a beneficiary (or within a class of beneficiary) of a discretionary trust which itself holds units in a unit trust that owns the dutiable property.

Is there an alternative way of mitigating the risk?

Where outcomes such as the above arise, it may be worth reconsidering ways that the property settlement could be done.  For example, rather than transferring the property owned by the unit trust to the receiving spouse, could the receiving spouse instead receive the units in the unit trust as part of the matrimonial property settlement.

Putting aside commercial considerations of such an arrangement, this would avoid the need for the dutiable property itself to be transferred and may potentially address the uncertainty surrounding the section 44(1) transferor condition.

However, the duty consequences of transferring the units themselves, would need to be considered, including whether the transfer of the units itself attracts landholder duty and whether any exemption or concession is available in those circumstances.

Corporate Ownership

There is also a separate relationship breakdown duty exemption where the transferor is a corporation. However even where all the conditions are satisfied and the transfer qualifies for duty exemption, other tax exposure such as Division 7A may nevertheless arise.

Matrimonial property settlement should not be viewed simply as a division of assets between separating spouses. The legal ownership structure, CGT rollover relief requirements, duty exemptions and the potential Division 7A and FTDT consequences all need to be considered to ensure that the proposed settlement does not produce unintended tax or duty liability.

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