Ruling Compendium

Separated couples may have already reached a property settlement in reliance upon the Commissioner's previous position and it would be inappropriate for the financial effect of those settlements to be altered by a retrospective change in the administration of the tax law, which will inevitably disadvantage one party over the other. This may lead to applications being made to set aside Orders or BFAs, which will involve considerable legal cost to parties and a substantial financial impost to the community given that court resources will need to be devoted to the determination of these complex applications.

This achieves a prospective application in respect of that issue and is consistent with the Commissioner's undertaking in PS LA 2011/27 and with subsection 358-10(2) of the Taxation Administration Act 1953.

The Commissioner does not consider a general administrative practice existed in relation to the other issues. Accordingly, and consistent with PS LA 2011/27 the application date of the Final Ruling in respect of such issues is both prospective and retrospective.

When the transferee later disposes of that asset that subsequent disposal will be subject to the CGT provisions to the extent of any difference between the asset's original cost base and the market value of the asset at the time of that subsequent transfer.

Prima facie there appears to be no relief from double taxation where there is a subsequent capital gain as subsection 118-20(1) of the ITAA 1997 only applies if the double taxation arises 'because of the event'. As the assessable dividend arises independently of the subsequent CGT event it would therefore appear that subsection 118-20(1) cannot apply to prevent double taxation.

It would provide an unacceptable outcome if the property is to be the personal residence of one of the spouses.

However, the fact that the gain on the transfer is ultimately subject to taxation, and that a party in receipt of a dividend is assessable on that dividend, is not of itself controversial. For example, if (outside Family Law proceedings) the company were to transfer an asset to a shareholder, the shareholder would be assessed on the value of the asset as a dividend, and the company would be assessed on any capital gain resulting from that transfer. That is, both amounts would likewise be taxed - though a credit may ultimately be available for the tax paid by the company via the imputation regime.

It is acknowledged that such credits are not available where the incidence of taxation falls on the matrimonial party rather than on the company. However, the matrimonial party may have concessions available to them that are not available to the company, such as the CGT discount, which is calculated from the time the company acquired the asset: See item 1 of the table to section 115-30 of the ITAA 1997.

Section 118-180 of the ITAA 1997 specifically provides that the main residence exemption is not available in respect of the period the property was held by the company, though it will be available (where it is otherwise satisfied) in respect of any growth in value of the property after this time.

The Board of Taxation, in the context of its Post implementation review into Division 7A, has been made aware of these issues.

For completeness, the Final Ruling now explains the basic operation of Subdivision 126-A of the ITAA 1997.

It should also be noted that these consequences do not arise if the transfer of property is not 'because of' the section 79 order (that is, if the transfer of property is not in compliance with that order). For example, if the order requires that money be paid, and the parties separately agree to satisfy that obligation by the transfer of property, the transfer of property is not 'because of' the order in the strict sense, and the roll-over provisions and cost base adjustment of the shareholder's interests in the private company will not occur. Instead, the company will be assessed on any capital gain that arises upon that transfer.

It would be contrary to the known policy intent of Division 7A, to exercise the section 109RB discretion in a 'blanket' way to limit the amount of the deemed dividend in the manner proposed.

Thus, despite the Commissioner's prior long standing administrative practice, there is no policy reason to justify the tax free payment of monies or property to a person solely because of inter alia entering into a binding financial agreement, or obtaining an order under section 79 of the FLA.

However, the reasoning adopted by the Commissioner in the Draft Ruling is incorrect and the relevant provisions of the tax law do not necessarily achieve the result contended by the Commissioner in the Draft Ruling.

Rather, to achieve the intended policy outcome, the legislature must amend the tax law to remove any doubt.

In terms of transfer of property to a shareholder, the Commissioner makes no statement in the Draft Ruling concerning paragraph 109J(a) because it is the Commissioner's view this is captured by a plain operation of section 44 of the ITAA 1936 (refer also to paragraphs 58 to 67 of TR 2013/D6).

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that the company must have a liability

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the liability must be expressed as a value, and

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the means of extinguishing that liability is by the payment of something of value, not just a specific kind of property.

The tax position with respect to such payments and transfers of property will therefore both be consistent and clear on issue of the Final Ruling. It is anticipated that having such a published ATO view on these matters will lessen the uncertainty.

Unfortunately, it would be open to the departing spouse to now seek a private ruling, allowing the Commissioner to treat the receipt of the payments as an assessable dividend and issuing an assessment.

This would then result in the remaining spouse now being called upon to satisfy the liability because of the amended assessment under the tax indemnity previously provided. In such case, it would also expose the remaining spouse's legal and financial advisers to a professional indemnity claim.

In terms of the issue of whether Division 7A applies to payments of money by a private company to an associate of a shareholder, the Final Ruling has only prospective application (refer issue 1). Accordingly, indemnities in respect of such payments ought not to be effected.

In particular we contend that any payment of money or transfer of property by a private company to an associate of a shareholder made pursuant to an order of the Family Court of Australia (the Family Court) on a matrimonial settlement is invariably made on the basis that the private company and non-shareholder spouse are dealing on an arm's length basis as the payment or property transfer has only occurred because the Family Court has made an order to that effect.

Further, as noted at issue 1, the Final Ruling has prospective application in respect of the 'payment of money to associates' issue.

In many cases, orders made under the Family Law Act are not made in order to give effect to or make enforceable a settlement reached by the parties through their own negotiation, rather the Family Court will make a determination of the appropriate division of the matrimonial property independently of the wishes or proposals of the parties. In these circumstances, an obligation will be imposed on the parties, rather than the parties (including the private company) submitting to those obligations by agreement. In such a case, we submit that it is difficult to see how the payment made by the private company pursuant to the Family Court Order can be characterised as being 'voluntary and therefore, gratuitous.

This is not the reality where there is a marital breakdown. It is invariably the case that the divorcing couple will be vigorously competing for their respective self-interest in securing their entitlement to the assets of the marriage.

It is often the case that the private company will have other shareholders and directors involved in the matrimonial dispute in addition to one of the spouses. Moreover, these shareholders and directors will be entirely independent and unrelated to a spouse of the marriage. In these circumstances we understand that the Family Court is able to impose orders for the division of matrimonial assets against a company even where one of the spouses is not the sole shareholder and/or director, provided that the company is a party to the Family Court proceedings and has been afforded procedural fairness. In this case, the 'parties' (particularly the private company) are not only in an arm's length relationship because of the independent representation on the board, but their dealing is also very much of necessity at arm's length.

The Family Court must always exercise its own discretion on whether to make an order under section 79 of the FLA, and, if so what orders to make. This is so even if orders are sought by consent - see Harris v. Caladine (1991) 172 CLR 84 at 96, 103-104, 124, 133.

A private company which is made party to the proceedings is similarly subject solely to the Court's jurisdiction in the same way as the matrimonial parties. This means, the obligation is in law unilaterally determined by the Court having regard to the submissions and evidence made to the Court. The obligation arising out of the Order does not crystallise from a dealing between the parties to the proceedings (being the private company and the recipient of the payment that is contemplated in paragraph 109J(a) of the ITAA 1936).

Paragraph 109J(b) is as a matter of construction not concerned with whether the parties are 'at arm's length' which is a different technical legal question.

What paragraph 109J(b) seeks to construct is an alternative hypothesis concerning an obligation that crystallises from a dealing between the private company and the recipient of the payment. Dealings between the recipient and a third party (such as the other matrimonial party) are not relevant in that context.

Based on the words in the legislation it seems clear to us that the enquiry should be about whether the 'amount of the payment' is an arm's length amount. In other words, the obligation to pay an amount and the circumstances in which that obligation arose do not require one to construct an alternative hypothesis.

Moreover, we believe that the comments made by Lindgren J in Di Lorenzo Ceramics Pty Ltd & Anor v. FCT [2007] ATC 4662 actually support such an interpretation of paragraph 109J(b).

Lindgren J did not consider an alternative hypothesis about how the obligation came about. His Honour only made reference to whether the price under the relevant agreement was no more than the one that would have arisen if the parties had been dealing with each other at arm's length.

In our view, if the parties are dealing with each other at arm's length, it follows that the amount of the payment required under an obligation (however that arises) must be the arm's length price. This view is consistent with the decision in Granby Pty Ltd v. FCT [1995] 30 ATR 400.

In the circumstances where a Court of Law makes an order for a private company to make a payment to an entity, it would in our view be hard to consider a situation where the parties would not be dealing at arm's length.

Rather, paragraph 109J(b) uses the words, 'is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length.'

This is a different statutory context to that in Granby Pty Ltd v. FCT [1995] 30 ATR 400 (Granby). That case was concerned merely with whether the parties were dealing with each other at arm's length in respect of the actual transaction in contemplation. The context was not one of measuring that which had transpired against something else.

Further, as is also explained in Granby, parties may be at arm's length and arrive at an arm's length amount yet by reason of benefiting a 3rd party, the test of 'dealing with each other at arm's length' may not be satisfied. In that Case, Justice Lee said

That is not to say, however, that parties at arm's length will be dealing with each other at arm's length in a transaction in which they collude to achieve a particular result, or in which one of the parties submits the exercise of its will to the dictation of the other, perhaps, to promote the interests of the other.

In Di Lorenzo Ceramics Pty Ltd & Anor v. FCT [2007] ATC 4662 (Di Lorenzo Ceramics), Lindgren J, was silent on how the 'price the parties would have agreed upon if they had been dealing with each other at arm's length' would be determined (were it necessary to do so).

Issue 15 explains why in the Commissioner's view parties to proceedings before the Family Court are not engaged in a 'dealing' such that Family Court proceedings cannot be used as the test for paragraph 109J(b) purposes.

In our view, the $1,000,000 payment is a pecuniary obligation determined by a Court. As the obligation to pay the $1,000,000 arose from a Court Order, the $1,000,000 ought to be considered an arm's length amount. As such the compensation payment should satisfy the criteria in section 109J of the ITAA 1936.

We do not consider that an order made by the Family Court should be treated any differently to an order made by another Court.

In such circumstances an equivalent amount might be expected to be agreed. The benefits of settlement are as usual the savings to both parties in terms of the time and costs of litigation.

The agreement to settle would impose an enforceable obligation in contract on the private company. This is because consideration passes in respect of the promises made by both parties. In the case of the injured party, it is the forbearance to pursue the cause of action in tort that represents the necessary consideration.

Whether paragraph 109J(b) is satisfied in any particular case is ultimately a matter to be decided having regard to the facts of each case.

The Explanatory Memorandum to Taxation Laws Amendment (2007 Measures No 3) Bill 2007 (EM) which inserted section 109RC of the ITAA 1936 makes it clear payments made in satisfaction of relevant Family orders are intended to be assessable as dividends. The Explanatory Memorandum relevantly states:

Under the current law, transfers of property and other 'payments' in respect of marriage or relationship breakdown are caught by Division 7A even though they may be non-voluntary (eg by court order). [paragraph 1.44]

We are concerned because it crucially omits the last sentence of that paragraph, specifically: "As such a deemed dividend may arise."

Thus, a deemed dividend may not necessarily arise (for example, if one of the exemptions in Subdivision D of Division 7A applies, such as section 109J).

For completeness, we have included the entire paragraph when quoted at paragraph 155 of the Final Ruling.

However, these examples do not include any references to existing shareholder or associate loans to the private company and how the repayment of such loans in accordance with a Family Court order would be treated by the ATO.

We would therefore like these examples to be expanded to deal with the situation where the private company is ordered to repay an existing loan due to the shareholder's associate together with confirmation that such a payment would not be treated as a deemed dividend for Division 7A purposes as it is a repayment of an existing obligation.

Nevertheless, the Commissioner agrees that where an order is made under section 79 of the FLA for a private company to make a payment of money in satisfaction of an antecedent debt between the private company and an associate of a shareholder (the associate), the payment made in conformance with that order nevertheless remains in discharge of the antecedent debt.

The antecedent debt is a pre-existing obligation in contract for the private company to make a payment of money to the associate. The obligation arises as consideration for the prior lending of that amount of money by the associate to the private company

The obligation in contract is an obligation to pay money as contemplated by paragraph 109J(a) of the ITAA 1936.

Further, the payment of money to discharge the obligation is of the same quantum as that which would be required between parties engaged in a borrowing on arm's length commercial terms. That is, the alternate hypothesis in this case would result in an obligation of the same quantum and a payment of money in discharge of that obligation also of the same quantum.

Notwithstanding that the payment is ordered under section 79 of the FLA, it nevertheless remains in discharge of the obligation founded in contract.

For these reasons, the payment to discharge the antecedent debt also satisfies the requirements of paragraph 109J(b) of the ITAA 1936 meaning section 109J stops the payment from being treated as a dividend under section 109C of the ITAA 1936.

To avoid confusion, the Final Ruling makes it clear that payments made in discharge of a debt in existence apart from matrimonial proceedings are excluded from the definition of a 'section 79 order' (that otherwise gives rise to dividends).

However, separate to gains made in respect of such assets, any payment or transfer to a matrimonial party under a section 79 order as described in the Final Ruling, also gives rise to an assessable dividend.

Section 15AB of the Acts Interpretation Act provides in essence that in the interpretation of a provision of an Act, these can be considered to confirm that the meaning of the provision is the ordinary meaning conveyed by the text or to determine the meaning of the provision when the provision is ambiguous or obscure or when an ordinary meaning conveyed by the text leads to a result that is manifestly absurd or unreasonable.

We submit that as the words of paragraph 109J(b) of the ITAA 1936 clearly require that the payment made by the private company be not more than would have been required to discharge the obligation had the company and the entity been dealing with each other at arm's length in relation to the Family Court proceedings. Consideration of what a private company may pay to a non-shareholder 'in a commercial setting', that is, outside of the Family Court setting is not required.

The identification of an alternative hypothesis, as the authorities in a similar statutory context require, necessitates consideration outside the Family Law context where such dealings do arise (that is in a commercial setting).

The interpretative enquiry therefore necessitates consideration of a commercial setting rather than doing so because of any reliance upon extrinsic materials.

In the Final Ruling, the Commissioner observes that the outcome of interpretative enquiry is consistent with what is apparent from the extrinsic materials.

However, in some circumstances it may be the case that the anti-avoidance provisions in Part IVA of the ITAA 1936 will apply. For example, we consider that it would be more likely that Part IVA would apply if both spouses were to receive a payment of cash from a private company pursuant to court orders, but one or both parties remain owners of the company. In these circumstances it would appear that the purposes of at least one of the payments is not to sever ties with the company to achieve a final separation of the parties. However, as is always the case with Pat IVA, the facts of each particular case will need to be considered.