Division 7A – Is There a Liability?

by Byron Leong on October 28, 2016

Byron Leong

Before a Court can make an order pursuant to the Family Law Act 1975 about how to divide assets of married or de facto parties, it must first work out the “legal and equitable interests” of the parties available for division. This means that the Court must work out the total net value of assets. The total net value of assets is determined by deducting the total gross value of liabilities of the parties from the total gross value of their assets. This may not be easy to do particularly when the parties are involved in businesses that operate through companies and family trusts giving rise to complex taxation structures.

The Full Court of the Family Court of Australia was required to consider the impact of a significant potential tax liability in the decision of Rodgers and Rodgers [2016] FamCAFC 68. The Husband and Wife in this case owned a tourism business that operated through a trust. The business income was held in a “bucket company” and the parties then used the funds in the bucket company for their own use. Division 7A Loan Agreements were entered into between the company and the trust to minimise and defer the tax to be paid on funds used by the parties.

Evidence was produced by an accountant for the Husband that the potential tax liability arising from the Division 7A Loan Agreements was between $517,000 and $791,000 depending on whether or not the loans were forgiven in the financial years ending 30 June 2014 or 30 June 2015. The Husband wanted the Trial Judge to include in the liabilities of the parties the potential tax liability in the sum of $517,000. The Trial Judge did not accept that the potential tax liability should be included as a liability of the parties in determining the total value of assets available for division between them. Whilst the Trial Judge did not include the potential tax liability in the total value of assets for division, Her Honour did take it into account when considering if any adjustments to the division of assets should be made in favour of the Husband on the basis that he may potentially be responsible for a significant tax liability in the future.

The Husband appealed the decision of the Trial Judge on the basis that Her Honour was incorrect in not including the potential tax liability in the assessment of the assets to be divided between the parties or the size of the adjustment that she made in favour of the Husband for the potential tax liability to be met by him. The position was better for the Husband if the potential tax liability was taken into account as a liability in the assessment of the assets for division, as it meant that the potential liability taken into account at $517,000 would be shared between the Husband and the Wife. If the potential tax liability was only taken into account as an adjustment factor, then the full value of the potential liability would not be fully shared between the parties and the Husband would potentially be responsible to pay more of it.

The Full Court commented that there is no rule that it is “mandatory” that a liability must be deducted from the total gross value of the assets of the parties, however it makes sense to do so. The exception to this is if the liability is “vague, uncertain, unlikely to be enforced” and in all the circumstances of the particular matter it would be unjust and inequitable for the liability to be deducted from the total gross value of assets. The Full Court found that the Trial Judge did not make a mistake in excluding the potential tax liability arising from the Division 7A Loan Agreement from the total value of assets available for division. The Full Court accepted the Trial Judge’s finding that there was insufficient evidence that the potential tax liability of $517,000 would be required to be paid in the future.

Whilst the Full Court accepted that the potential tax liability should not be taken into account in total value of assets, the Trial Judge gave insufficient weight to the potential tax liability as an adjustment factor. As a result the Full Court granted the appeal.

This case shows the seriousness of what can happen when there are complicated business structures and arrangements. In this case, the Husband was left with a potential tax liability of between $517,000 and $791,000.

If you have a family law matter that has complex business structures and arrangements, it is important that:

  • You and your lawyer understand how your business operates, the business structure and how the income is distributed;
  • You are aware of any Division 7A Loan Agreements and the implications of such Agreements;
  • An accountant and taxation lawyer are involved in your matter as soon as possible after separation to assist with understanding the business structure and any potential tax liabilities that may arise from any potential order or agreement about the division of assets.

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