Private ruling: Capital gains tax – marriage breakdown – roll-over relief
Date of advice: 6 November 2018
Published: February 2019
Ruling period: Year ending 30 June 2019.

Ruling: Q1: Will the capital gain that will be made by the transferor company on the disposal of the property be disregarded pursuant to subdivision 126-A of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. The capital gain will be disregarded pursuant to subdivision 126-A of the ITAA 1997 if the property is transferred under an order of the Family Court pursuant to the Family Law Act 1975 . | Q2: If the roll-over provisions in subdivision 126-A of the ITAA 1997 apply to the transfer of the property, how is the cost base of the shares in the company calculated? | A2: The cost base of the shares will be reduced under subsection 126-15(3) of the ITAA 1997 by the value of the property transferred as a result of the trigger event. Under subsection 126-15(4) of the ITAA 1997 the cost base of the shares will then be increased by the amount included in the shareholder’s assessable income because of the trigger event.

Relevant facts and circumstances: Your Firm Pty Ltd was established in 199X and is an Australian resident company. Your Firm Pty Ltd purchased a residential property in 199Y, which has been leased to The Taxpayer since then. The Taxpayer owns the majority of ordinary shares in Your Firm Pty Ltd. The Taxpayer is in the process of negotiating a final divorce financial settlement with their spouse. As part of this divorce settlement it is intended that the residential property be transferred from Your Firm Pty Ltd to The Taxpayer on foot of a Family Court order and that the marriage breakdown rollover would be applied by Your Firm Pty Ltd under subdivision 126-A of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Section 110-25 | Subdivision126-A | Section 126-5 | Section 126-15 | Section 126-20 | Section 126-25 | Income Tax Assessment Act 1936 Division 7A | Section 109RC | Taxation Administration Act 1953 Schedule 1 | Section 357-110 | Family Law Act 1975 Section 79

Reasons for decision: Detailed Reasoning - 126-A roll-over: As a general rule, capital gains tax (CGT) applies to all changes of ownership of assets on or after 20 September 1985. However, if you transfer an asset to your spouse as a result of the breakdown of your marriage or relationship, there is automatic rollover in certain cases. The rollover applies if your marriage or relationship ended on or after 20 September 1985, and: ● you transfer an asset or a share of an asset to your spouse ● you receive an asset or a share of an asset from your spouse, or ● a company or trustee of a trust transfers an asset to you or your spouse. Section 126-15 of the ITAA 1997 deals with a roll over for a CGT event involving a company or a trustee and a spouse or former spouse. Subsection 126-15(1) of the ITAA 1997 states that the roll over consequences in section 126-5 of the ITAA 1997 apply if the 'trigger event' involves a company or a trustee and a spouse or former spouse of another individual and occurs because of: ● a court order under the Family Law Act 1975 or under a state or territory law, or foreign law relating to breakdowns of relationships between spouses ● a financial agreement that is binding under section 90G of the Family Law Act 1975 (known as a 'binding financial agreement') or a corresponding written agreement that is binding because of a corresponding foreign law ● a financial agreement that is binding because of section 90UJ of the Family Law Act 1975 (known as a 'binding financial agreement') or a corresponding written agreement that is binding because of a corresponding foreign law. ● an award made in an arbitration referred to in section 13H of the Family Law Act 1975 (known as an 'arbitral award') or a similar award under a corresponding state, territory or foreign law - such as an award made under the Western Australian Family Court Act 1997 , or ● a written agreement that is binding because of a state, territory or foreign law relating to breakdown of relationship between spouses and that, because of such a law, a court is prevented from making an order ● about matters to which the agreement applies, or ● that is inconsistent with the terms of the agreement, in relation to those matters, unless the agreement is varied or set aside. Where the conditions for the relief are met, the relief applies automatically; it is not necessary for the taxpayer to elect for the relief to apply and it is not possible to elect that it not apply (Taxation Determination TD 1999/60). | Detailed Reasoning - Dividends: Section 44 of the ITAA 1936 specifically includes dividends in a taxpayer’s assessable income. Paragraph 44(1)(a) provides that the assessable income of a resident shareholder in a company includes: (i) dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and (ii) all non-share dividends paid to the shareholder by the company… Dividends are defined in subsection 6(1) of the ITAA 1936 as including: (a) any distribution made by a company to its shareholders, whether in money or other property; and (b) any amount credited by a company to any of its shareholders as shareholders… Paragraph 4 of Taxation Ruling TR 2014/5 Income Tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate) (TR 2014/5) explains that a transfer of property by a private company to a shareholder that is made in compliance with a section 79 of the Family Law Act will be an ordinary dividend to the extent that it is paid out of the private company profits. The transfer will be assessable income of the shareholder pursuant to section 44 of the ITAA 1936. TR 2014/5 further explains at paragraph 69 that the characterisation of the transfer of property as a dividend is not altered by the fact that it is made to give effect to an order by the Family Court. That is, the cause for the directors resolving to make the transfer to the shareholder does not alter its character. The meaning of the term ‘out of profits’ is not defined in the legislation however there has been judicial consideration of the issue which suggests that: a. ‘profits’ implies comparison of the business’ performance at two specific points in time, generally separated by an interval of a year, and b. dividends do not need to be paid out of a profit or dividend fund to be considered to be paid out of profits for the purposes of subsection 44(1) of the ITAA 1936. Further guidance on the meaning of paid out of profits is provided in Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders – amount to be included as an assessable dividend (TR 2003/8). Specifically, paragraph 8 and 13 state that if the company’s assets are greater than its liabilities and share capital immediately after the payment of the dividend, then it will be considered to have been made out of profits. | Detailed Reasoning - Cost base adjustments: Paragraphs 132 to 134 of Taxation Ruling TR 2014/5 set out the consequences of a company asset being transferred to a shareholder under a section 79 order of the Family Law Act 1975 : 132. Just as in ordinary circumstances where an in specie distribution to a shareholder might give rise to an incidence of taxation to the private company under the CGT regime and also an incidence of taxation to the shareholder under section 44 of the ITAA 1936, so too may a dividend arise upon a transfer of property in compliance with a section 79 order (under section 44, whether or not via Division 7A) and CGT consequences separately arise in respect of that transferred property. 133. Broadly, where the transfer of property from a private company to a matrimonial party in compliance with a section 79 order would otherwise have CGT consequences for the private company, Subdivision 126-A of the ITAA 1997 generally defers those consequences until such time as that matrimonial party disposes (or otherwise deals) with that property (and instead visits those consequences on that party). It does this primarily by: ● disregarding the capital gain or capital loss made by the private company upon the transfer, and ● treating the matrimonial party as having the same cost base (or reduced cost base) as the private company at the transfer time (or - where the asset was acquired by the company prior to 20 September 1985 - treating the asset as having been acquired by the matrimonial party prior to that time). 134. In addition to these consequences, the cost base (and reduced cost base) of the shareholder's interests in that company may also be altered under Subdivision 126-A of the ITAA 1997. Specifically, if property is transferred in compliance with a section 79 order by a private company to a shareholder, the cost base of that shareholder's shares in the private company may be both: ● reduced under subsection 126-15(3) of the ITAA 1997 (broadly by the fall in market value of those shares caused by the property transfer), and ● increased under subsection 126-15(4) of the ITAA 1997 (broadly by the dividend assessed to the shareholder). Accordingly, the cost base of the shares in Your Firm Pty Ltd will be reduced by the amount included in The Taxpayer’s assessable income – in this case, the market value of the residential property. The cost base of the shares will then be increased by the value of the dividend assessed to the shareholder (The Taxpayer). Section 109RC of the ITAA 1936 provides that deemed dividends arising from payments in respect of marriage or relationship breakdown may be frankable by the private company taken to pay the deemed dividend. The private company may frank the dividend in accordance with Part 3-6 of the ITAA 1997, subject to the dividend being franked at the private company’s benchmark franking percentage, or if no franking percentage exists, at 100%. As Taxation Ruling TR 2014/5 makes no reference to franking credits in its discussion of cost base adjustments, we do not consider that the cost base of the shares should be increased by the value of franking credits attaching to the deemed dividend.