You are acting for Clive in relation to the breakdown of his marriage with Alice. Clive is a cosmetic dentist and has done very well financially. Alice has also been very successful running her interior design business. The breakup has not been harmonious. Negotiations broke down after a year of acrimony but the later the mediation was successful, if arduous and with little compromise, and with no time to seek outside advice.
One of the bones of contention during the marriage was the different approach to risk. Clive worried mightily about being sued by one of his high net worth clients if the cosmetic dentistry didn’t work out correctly. Alice was much more relaxed about her business.
As a consequence most of Clive’s property was tied up in a trust while Alice owned her assets personally – with one property owned by them jointly. Clive also owned a half share with his sister Ann in a property inherited from their parents.
Clive had a paranoid desire to improve his risk profile by exchanging his half share in both properties for Alice putting listed shares of the same value into his trust. This suited Alice because she wanted to balance up her investments - but problems remained.
While they agreed on the value of the property Clive owned with Ann, they could not, during the mediation despite endless haggling, agree on the value of the property they owned together.
So, it was agreed that the property would be sold with Alice taking all of the sale proceeds. It would then be easy to work out how many shares should be transferred to Clive’s trust.
Although Alice was happy with becoming half owner with Ann she worried about the unhappy relationship that had developed with Ann during Alice’s marriage breakdown. It was therefore agreed that Clive would declare a trust of his half share with power for Alice to request a transfer when things had improved with Ann.
After a long and exhausting day the mediation agreement was signed
It doesn’t take long to realise that despite the pressures, any property settlement needs proper analysis before becoming final.
First problem: selling the jointly owned property. It was bought in the 1990s so consequently had a very significant capital gain on sale. Even though done in the course of a property settlement, there is no CGT relief.
Section 126-5 of the Income Tax Assessment Act 1997 (ITAA 1997) gives relief when a property is transferred between spouses. Section 126-15 applies when property is transferred from a family company or family trust to a spouse. But neither happened here - the property was simply sold so CGT event A1 applied with the capital gain being the capital proceeds from the sale less the cost base. At least the general discount applied so that only half the capital gain was assessable.
Perhaps, it was suggested, Clive’s obligation to pay Alice his share of the sale proceeds would entitle him to a capital loss to offset the capital gain. The same situation cropped up for the spouses involved in private binding ruling 1011678016273 where the ATO made it clear that;
(a) CGT was payable on the sale; and
(b) there was no entitlement to a capital loss on the payment between spouses.
Second problem: the declaration of trust – Clive is liable for CGT.
There are no less than 56 potential CGT events but only 6 are covered by exemptions on marriage breakdowns. Declaring a trust over an asset triggers CGT event E1- which is not exempt. The capital gain comprises the capital proceeds from creating the trust less the asset’s cost base.
The share portfolio that Clive’s trust received from Alice qualifies as capital proceeds for the declaration of trust. Sections 116-20 and 103-10 include as ‘capital proceeds’ property transferred to another by direction. Alice transferred property (the share portfolio) to Clive’s trust at Clive’s direction.
Third problem: transferring Alice’s share portfolio – Alice is liable for CGT. Section 126-15 gives relief when a company or trust transfers property to a spouse but there is no relief for the reverse. Despite the connection to a property settlement under the Family Law Act, there is no relief available to Alice from CGT event A1.
Under section 116-20 the capital proceeds from a CGT event include property you receive ‘in respect of the event happening’. The “event” is Alice’s transfer of shares to Clive’s trust. Alice only agreed to transfer her shares to Clive’s trust because of Clive’s agreement to transfer the property and sale proceeds to her.
The sad result is that CGT is payable on all the disposals.
1. Despite time pressures, always be clear on the CGT consequences of the property settlement.
2. Not all CGT events are exempt under a family law property settlement.
3. Avoid agreements to “sell and split”.
This article is general information only and should not be relied on without obtaining further specific information.
By Jim Main