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In this article, we discuss eight tax issues that can often be overlooked. Family lawyers should be aware that these can potentially affect the asset pool, create future liabilities, and expose clients to potential risk. These issues can affect both the immediate settlement and the long-term financial outcomes for clients.
UPEs represent amounts owed by a trust to beneficiaries. They are not ‘paper entries’ that can be ignored or creatively reallocated. Attempts to forgive or transfer UPEs – such as reallocating a spouse’s entitlement to another via journal entry – can trigger capital gains or other tax consequences.
Key takeaway: UPEs must be properly identified, valued, and addressed in the matrimonial balance sheet. They are real liabilities and may require independent tax advice as to how to deal with as part of the property settlement.
When trust distributions are made to one person but used by another – such as adult children’s entitlements benefiting parents that are taken to arise from a reimbursement agreement – the ATO may deem the trustee liable for tax at the highest marginal rate (currently 47 per cent). There is no limitation period for review. This represents a potential for a tax liability to arise that is not quantified in the matrimonial balance sheet.
Key takeaway: Ensure alignment between who receives the distribution and who benefits. Reimbursement arrangements must be valid and documented.
The Carter decision1 confirmed that attempts by beneficiaries to disclaim entitlements after the financial year end have no effect for tax purposes. Once a trust distribution entitlement is determined (usually as at 30 June), the tax position is locked in. Attempts to disclaim entitlements can lead to disputes, delayed returns, and unnecessary tax liabilities.
Key takeaway: Proactive management of trust distributions is critical – especially in the lead-up to 30 June. Clients must understand the risks of being named as a beneficiary without receiving cash.
FTEs restrict distributions to the family group of the specified individual. Post-divorce, if the retaining spouse is no longer part of that group, future distributions (e.g., to a new spouse or their children) may attract Family Trust Distributions Tax (FTDT) at 47 per cent. Read our recent insight for more information.
Key takeaway: Check FTE and IEE status early. Consider restructuring if future distributions are planned outside the original family group.
Gifts or loans from foreign trusts or estates can be taxable under section 99B2 – even if they’re still repayable. Failure to identify and consider the potential exposure of section 99B can mean the matrimonial balance sheet does not properly reflect all liabilities attaching to the parties’ assets. Section 102AAM can impose interest charges that effectively double the tax liability. This is a growing area of ATO focus due to the internationalisation of Australian wealth. See our recent insight for more information.
Key takeaway: Understand and take time to understand the source of any foreign funds. Tax liabilities can exceed 100 per cent of the amount due to interest charges.
Rollover relief on marriage breakdown defers CGT, but doesn’t eliminate it. The transferee inherits the original cost base, not market value. The fact that this relief is only temporary is often not understood or factored in by the spouse receiving the CGT asset.
Key takeaway: Model future CGT scenarios and ensure clients understand the long-term implications. Rollover relief is automatic unless proactively excluded.
The main residence exemption is complex and periods of absence, income generation, and foreign residency all affect eligibility. In a case involving joint ownership, different living patterns led to different tax outcomes for each spouse. With property assets increasingly representing large portions of family wealth, ensuring main residence exemption is appropriately quantified is important.
Key takeaway: Document residence history and usage. Spreadsheeting facts is essential for accurate CGT calculations.
Transfers from private companies due to family law obligations can be franked under section 109RC3, even if the recipient isn’t a shareholder. This can significantly reduce tax payable. For example, a $5m transfer could attract $2.3m in tax if unfranked, but only up to $1.47m if franked – or even nil, but tax deferred, if structured through a company.
Key takeaway: Explore the use of s109RC. Cooperative tax planning by both spouses can unlock optimal outcomes for both parties.
One of the most important insights from the above is to remember that not every dollar in the asset pool is equal. Without proper tax analysis, the division of assets can potentially lead to very different net financial outcomes in the short to medium term for spouses.
1 Commissioner of Taxation v. Carter & Ors [2021] HCAASP 44
2 Section 99B, Income Tax Assessment Act 1936
3 Section 109RC, Income Tax Assessment Act 1936
