How does CGT liability apply in Family Law settlements?
On 22 March 2017 McKerracher J of the Federal court handed down his decision in Sandini Pty Ltd v Commissioner of Taxation. The Court declared that a transfer of shares from the trustee of a trust controlled by one partner in a marriage breakdown to the trustee of a trust controlled by the other partner was subject to the Capital Gains Tax (‘CGT’) concession in Subdivision 126A of the Income Tax Assessment Act 1997 (‘1997 Act’).
If it stands this decision overturns the widely held view that in order to obtain the relief in Subdivision 126A the transferee had to be the spouse him or herself; there may be more flexibility than was thought in obtaining CGT relief on a marriage breakdown.
The application by the husband and some of his related entities was for declaratory relief. The Federal Court is able to make a declaration under Section 21 of the Federal Court Act 1976 (Cth) which provides that the court may make a declaration on the legality of another party’s conduct.
Notably, the First Respondent in the matter was the Commissioner of Taxation for the Commonwealth of Australia. Additional respondents being the wife and the trustee of the trust she controlled which received the shares. The Commissioner being a party to the matter means he is bound by the decision (subject to appeal).
The question considered was whether a Family Court Order transferring an asset to a Family Trust can attract Rollover relief under Subdivision 126A of the 1997 Act. The relevant section is section 126-15(1) which provides:
“There are the roll-over consequences in section 126-5 if the trigger event involves a company (the transferor) or a trustee (also the transferor) and a *spouse or former spouse (the transferee) of another individual because of: (a) a court order under the Family Law Act 1975 or under a *State law, *Territory law or *foreign law relating to breakdowns of relationships between spouses; or …” [my emphasis].
The key issue was that the transferee was not the spouse herself but an entity, the trustee of a trust, which she controlled.
The facts are commonplace to any practitioner in the area of Family Law. On 21 September 2010 the Family Court made an order by consent that Sandini Pty Ltd in its capacity as the trustee of a trust controlled by the husband transfer some $2½ million in shares to the wife within 7 days. On 28 September the husband asked the wife for details for completion of the share transfer form and on 29 September 2010 she provided details of the trustee of the trust of which she was the principal beneficiary, the appointor and the sole director and secretary of that Trustee. On 30 September Sandini Pty Ltd executed the form using the details provided by the wife and on 4 October 2010 the transfer of shares was registered.
Sandini Pty Ltd claimed the rollover under Subdivision 126A which would result in no CGT being paid by Sandini Pty Ltd or by the husband as the income beneficiary of the trust for that year. Under the rollover the transfer itself is free of tax but the transferee obtains the shares with the cost base of the transferor. This means any subsequent transfer of the shares by the transferee, would result in the transferee paying CGT; not on the increase in value over current value but on the increase in value over the original cost to the transferor. Effectively the rollover shifts the burden of tax from one party in a marriage breakdown to the other.
The question was who should be taxed. The Commissioner submitted that there was genuine doubt about the proper application of the law in the circumstances. The difference in the after tax value of the shares transferred may be significant but the fact parties might subsequently revisit orders made by the Family Court did not bear upon orders made in the Federal Court.
Two separate arguments were considered:
1. that the making of the order by the Family court created a beneficial entitlement to the shares in the wife which entitlement amounted to her obtaining beneficial ownership of the shares thereby. This change in beneficial ownership was the original CGT event to which the rollover applied. Any subsequent transfer was from the wife and so subject to CGT in her hands; or
2. alternatively, the wife was sufficiently involved in the transfer to the trustee of the trust she controlled and that transfer took place ‘because of’ the Family Court order. These two facts being sufficient to satisfy the requirements of the legislation such that the transfer to the trustee was itself subject to the concession under subdivision 126A.
His honour considered the scheme of the CGT legislation which focuses on a change in beneficial ownership being the trigger for a taxable change of ownership. The express words of section 104-10 of the 1997 Act were considered and his honour formed the view that the making of the Family Court Order vested beneficial ownership in the wife which change of ownership was the relevant CGT event subject to concession.
His honour went on to say that there is also substance in the argument that constructive receipt occurs when money or property is applied for the benefit of a person at that person’s direction. The transfer of the shares to a trustee the wife controlled at her direction was, in his honour’s view sufficient. He read the section to require not that the spouse or former spouse be the transferee but that he or she be involved in the transfer. A transfer is required to be because of a Family Court order rather than in accordance with it.
If the making of a Family Court order can be sufficient to vest beneficial ownership in a party to the marriage the application of the rollover relief in Subdivision 126A is significantly changed and CGT may not apply to settlements as previously expected.
Even more radically, the view that the transfer to a trustee because of the order is sufficient to obtain the rollover widens the scope for settlements to involve more entities and so be more flexible and provides the opportunity for more tailored structuring in many family court matters.
It is worth noting that, given that the wife in this matter will probably receive a significant CGT bill she was not expecting, it seems likely the decision will be appealed.