Capital Gains Tax ("CGT") stands as a significant consideration in family court proceedings, governed by the provisions of the Income Tax Assessment Act 1977 (“ITAA”). It applies to assets acquired after 20 September 1985 and entails a tax on the net capital gain realised upon their disposal. This gain is calculated from the time of acquisition to the point of sale, based on the transferor's marginal tax rate. Certain assets such as a person’s primary residence are exempt from the payment of Capital Gains Tax.
In the intricate landscape of family law, where property settlements pivot on fair valuation and equitable distribution, understanding the implications of CGT is paramount. When parties to a family law proceeding seek inclusion of an investment property in their settlement, questions often arise regarding the future CGT liabilities that may accrue upon its eventual sale.[1]
Considering CGT is crucial when navigating capital gains tax in family court proceedings. For instance, in the scenario where ex-spouses are determining an equal division of assets, the valuation of an investment property becomes pivotal. Let us consider an investment property valued at $500,000. However, to accurately assess its worth for the purposes of equitable distribution, one must account for the potential CGT liability upon its eventual sale.
If the anticipated CGT liability upon the property's sale amounts to $22,000, then the property's value for division purposes would be $478,000 ($500,000 - $22,000). This adjusted valuation accounts for the anticipated tax liability and ensures a fair and equitable distribution of assets between the parties involved in the family court proceedings.
Clients are urged to assess their positions comprehensively, considering potential CGT implications attached to retained assets. In this blog post, we delve deep into the legal principles, recent case law, and practical considerations surrounding CGT in the context of family court proceedings. By shedding light on these crucial aspects, we aim to empower individuals with the knowledge needed to navigate CGT complexities effectively within the realm of family law.
ROSATI PRINCIPLE
At the heart of capital gains tax (CGT) considerations in family law lies the seminal case of Rosati v Rosati (1998) FAMCA 38. In this landmark case, the Full Court of the Family Court laid down fundamental principles guiding the treatment of CGT under Section 79 of the Family Law Act 1975 (Cth). Rosati's influence has been profound, shaping the approach to CGT in family law cases since its pronouncement.
In Rosati, the Full Court articulated a comprehensive framework for courts to consider when addressing CGT in family law proceedings. These principles, outlined below, serve as the bedrock for navigating CGT-related issues in property settlements:
Whether capital gains tax should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
If the Court orders the sale of an asset, or is satisfied that sale of it is inevitable, or would probably occur in the near future, or if the asset is one which is acquired solely as an investment and with a view to its ultimately sale for profit, then, generally allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
If none of the circumstances referred to in item 2 apply, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to midterm, then the Court, whilst not making allowance for the capital gains tax on such a sale in determining the value of the asset, may take that risk into account as a relevant Section 75(2) factor (matters to be considered when deciding property settlement cases).
There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood if a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.
Rosati underscores that the inclusion of CGT liability hinges on several factors, notably the likelihood of imminent sale or whether the asset was primarily acquired for investment purposes. However, the Court retains discretion in these matters, with determinations often being made on a case-by-case basis. This discretion ensures that each case is considered in its unique context, promoting fairness and equity in family law proceedings.
In summary, the principles elucidated in Rosati provide a comprehensive guide for courts to navigate CGT considerations in family law. By adhering to these principles, courts ensure that CGT liabilities are appropriately addressed, thereby facilitating fair and equitable property settlements.
CGT ROLLOVER RELIEF
In cases where shares are transferred between spouses due to the breakdown of a relationship, specific provisions under the Income Tax Assessment Act 1977 (ITAA) provide for capital gains tax (CGT) rollover relief. This relief, governed by Section 126 of the ITAA, ensures that CGT liabilities are deferred until the transferee spouse decides to sell or transfer the asset later.
The conditions for CGT rollover relief are stringent and require that the transfer of the asset occurs because of a formal court order, binding financial agreement, or court award. This ensures that the transfer is legally binding and recognized under family law provisions. Importantly, CGT is not payable by the receiving spouse at the time of transfer; however, it becomes payable when the asset is subsequently sold or transferred.[2]
Under CGT rollover relief, the transferee spouse assumes the CGT liability as though they had owned the asset from the date the transferor acquired it, and at the cost base it was acquired for. This mechanism facilitates the smooth transfer of assets between spouses during relationship breakdowns while deferring the CGT consequences until a later point in time.
The rollover relief provisions apply to various scenarios, including transfers resulting from:
Court orders under the Family Law Act 1975 or similar laws relating to relationship breakdowns.
Court orders made by consent, either under the Family Law Act 1975 or foreign laws.
Awards made in arbitration proceedings under the Family Law Act 1975 or similar awards under state, territory, or foreign laws.
Financial agreements that are binding under the Family Law Act 1975 or corresponding foreign laws, or written agreements binding due to state, territory, or foreign laws relating to relationship breakdowns, subject to meeting specific conditions.
It is important to note that each state and territory may have its own provisions regarding binding financial agreements, such as those defined under the Family Court Act 1997 (WA) in Western Australia. These agreements, often referred to as 'binding agreements used by separating couples,' must comply with the respective laws and conditions set forth in each jurisdiction.
Under the provisions of CGT rollover relief, the transferor is eligible for deferral of capital gains tax (CGT) liabilities in specific CGT events. These events include:
CGT event A1 - Transfer of Ownership: When the transferor transfers ownership of an asset to the transferee spouse.
CGT event B1 - Transfer of Right to Use: In cases where the transferor enters into an agreement granting the right to use a CGT asset to the transferee spouse, with title in the asset passing to the transferee spouse at the agreement's end. It is important to note that CGT rollover relief is applicable only if title in the asset passes when the agreement concludes.
CGT event D1 - Creation of Rights: If the transferor creates a contractual or other right in favour of the transferee spouse.
CGT event D2 - Grant or Renewal of Option: When the transferor grants an option to the transferee spouse or renews/extends an existing option granted to them.
CGT event D3 - Mining Entitlement: If the transferor owns a prospecting or mining entitlement and grants the transferee spouse a right to receive income from operations carried on by the entitlement.
CGT event F1 - Lease Renewal: In cases where the transferor, who is a lessor, grants, renews, or extends a lease to the transferee spouse.
For the CGT events, CGT rollover relief allows the transferor to defer CGT liabilities until the transferee spouse subsequently sells or disposes of the asset. This provision facilitates the smooth transfer of assets between spouses during relationship breakdowns while deferring the associated tax consequences until a later date.
CASE EXAMPLES
Taffner v Taffner (2021) 63 Fam LR 74:
In the 2021 case of Taffner v Taffner, the husband lodged an appeal against the orders issued by the primary judge, arguing that the judge failed to consider the capital gains tax (CGT) implications associated with his retention of a real property. He contended that the initial division of assets resulted in an imbalance, with the wife receiving a larger share (65.87%) than assessed by the primary judge (60.63%), who did not factor in the CGT liability.
The property earmarked for the husband's retention had to be sold following the final property orders, as he was unable to refinance the mortgage as outlined in the orders. The husband's appeal centred on the need for the court to re-evaluate its discretion concerning the treatment of the CGT liability incurred upon the sale of his property.
In this case, the appeal was successful in addressing the issue of CGT liability treatment. The court's decision reaffirmed the principles established in Rosati, underlining the importance of CGT considerations in property settlements. Specifically, the court emphasized that when assets are transferred between spouses through formal court orders or agreements, CGT liabilities may be disregarded, thereby facilitating a smoother transition of property between the parties involved.
The ruling in Taffner v Taffner highlights the necessity for courts to meticulously consider CGT implications in property settlements, ensuring equitable outcomes for both parties involved in family law proceedings. By acknowledging the significance of CGT considerations and reaffirming the principles set forth in Rosati, the court reaffirmed its commitment to upholding fairness and equity in property division matters.
Shnell & Frey [2021] FedCFamC1A 55:
In the case of Shnell & Frey [2021] FedCFamC1A 55, the Full Court examined the application of guidelines outlined in Rosati, a seminal case concerning capital gains tax (CGT) considerations in family law proceedings. Specifically, the court assessed whether the circumstances referenced in guideline (2) of Rosati were applicable to the case at hand:
‘If the Court orders the sale of an asset, or is satisfied that sale of it is inevitable, or would probably occur in the near future, or if the asset is one which is acquired solely as an investment and with a view to its ultimately sale for profit, then, generally allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.’
The wife in Shnell & Frey provided compelling evidence indicating her intention to sell an investment property within the next two years, with the aim of using the proceeds to purchase another property for residential purposes. Despite being unable to furnish the exact amount of the latent CGT liability, she presented evidence of the potential CGT payable if the property were sold at the time of the trial—an amount nearing $300,000.
The trial judge failed to recognize the likelihood of the property being sold soon, despite the wife's credible evidence supporting her intention to do so. The property, which had consistently been rented out, showed no indication of the wife's intent to occupy it before its sale.
Consequently, the Full Court held that the circumstances outlined in guideline (2) of Rosati were indeed applicable to the case. It was deemed appropriate for the latent CGT liability to be included as a liability of the wife in the balance sheet. This decision underscores the significance of considering CGT implications in property settlements, particularly when there is credible evidence suggesting an imminent sale of the asset. By adhering to the principles set forth in Rosati and recognizing the relevance of CGT considerations, the court ensured a fair and equitable resolution in line with the interests of both parties involved.
Marriage of Harrison (1996) 20 Fam LR 322
The Full Court, as cited in the Marriage of Harrison (1996) 20 Fam LR 322 at 332, highlighted a crucial aspect regarding the calculation of capital gains tax liabilities in family law proceedings. The court emphasized that CGT liabilities can only be accurately assessed when an immediate sale of the asset is contemplated. Without such contemplation, it becomes challenging to calculate any potential capital gains.
In the specific case discussed, there was no evidence to suggest that the company intended to dispose of its assets, nor did the husband express any intention to sell his shares. As a result, the court found it difficult to ascertain the extent of CGT liabilities.
While acknowledging the binding nature of the Full Court's pronouncement, it is important to note that in certain circumstances, it may be necessary to deviate from this principle. In some cases, even without immediate intentions of sale, considering the incidence of CGT could be warranted. The complexity of calculating the exact tax payable should not serve as a deterrent to acknowledging its potential impact.
While the Full Court's directive provides valuable guidance, each case must be evaluated on its own merits. There may be instances where departing from the strict interpretation is necessary to ensure fairness and equity in property settlements. Thus, while respecting judicial precedents, courts must remain flexible in their approach to CGT considerations, especially when the circumstances of a particular case warrant such flexibility.
CONCLUSION
In conclusion, navigating capital gains tax (CGT) in family court proceedings demands a nuanced comprehension of legal principles, evidentiary considerations, and judicial discretion. While the seminal case of Rosati lays down a foundational framework, recent case law underscores the evolving nature of CGT considerations. This evolution ensures that property settlements are conducted with fairness, equity, and sensitivity to the unique circumstances of each case.
By integrating insights from both established precedents and recent developments, individuals involved in family law proceedings can navigate CGT considerations with confidence and clarity. This guide aims to empower stakeholders, including litigants, legal professionals, and judicial officers, to effectively address CGT issues, thereby facilitating smoother and more equitable resolutions in family law matters.
A comprehensive understanding of CGT principles, coupled with a willingness to adapt to evolving legal interpretations, is essential in achieving just outcomes in family court proceedings. We trust that this guide has offered valuable insights into this complex aspect of family law, equipping individuals with the knowledge needed to navigate CGT considerations effectively.
Disclaimer: The information provided here is for educational purposes only and should not be considered legal advice. If you need legal assistance, we recommend contacting Carter Dickens Lawyers or consulting a qualified attorney. Legal matters can vary based on laws and regulations, and it is important to seek professional advice for your specific situation.
[1] For commentary on Capital Gains Tax and Family Law, see; Alison Shaw, ‘Capital Gains Tax and Family Law’ (2000) 14(4) AFL 12.
[2] For an overview of when the relationship breakdown rollover applies, see; Australian Taxation Office, ‘When the relationship breakdown rollover applies’ (Web Page, 29 June 2023.) < https://www.ato.gov.au/individuals-and-families/investments-and-assets/capital-gains-tax/relationship-breakdown-and-capital-gains-tax/when-the-relationship-breakdown-rollover-applies?=redirected_rollover>.
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