I was recently asked to review draft orders for tax implications which included:
“The Husband pay or cause to be paid to the Wife by way of final property settlement the sum of $1,000,000 within 28 days”.
Are there any possible negative outcomes for the Wife? What if the Husband makes the payment directly from his company?
Prima facie, the payment from the company direct to the Wife would be a payment from a company to an associate of a shareholder and therefore Division 7A of the Income Tax Assessment Act could deem this payment to be a dividend. Division 7A taxes the recipient of the payment and therefore the Wife could be liable to pay tax of up to $490,000.
You might think to yourself “It’s ok if that happened, because I put in an order that the Husband indemnify the Wife of any taxation implications”. But an indemnity still means that the Wife would need to pay the tax first and then try to get the money from the Husband. Therefore, isn’t prevention better than the cure? So how can we avoid or reduce the risk that the Wife will need to pay tax on such an order?
Firstly, remove the phrase “or cause to be paid”. That implies that the payment should be a personal obligation of the Husband, not something that he could cause an entity under his control to pay.
Next, the order could be expanded to:
“The Husband pay to the Wife by way of final property settlement the sum of $1,000,000 within 28 days. The payments are to be made in a manner that will not to cause any tax liability to the Wife. In the event that the Husband causes any payment to the Wife to be made directly from an entity under his control, the Husband will take all action necessary to ensure that the records of that entity record the transaction as a payment for the benefit of the Husband for the purpose of fulfilling his personal obligations to the Wife.”
In some matters the parties may be amicable and anticipate that a future payment could come from an entity under the control of one of the parties. However, the party receiving the funds would obviously want to ensure that they do not have an unforeseen tax liability and end up receiving less than anticipated. The party making the payment would obviously prefer to make the payment as tax effective as possible. Where this is the case, the following could be added to the above draft order:
“In the event that the Husband wishes to make a payment via a company or trust that could result in a tax liability to the Wife then he must obtain her written consent prior to doing so and ensure that the net amount to be received is at least equal to $XXX,XXX [OR] the relevant payment listed in the schedule below [if payments will be made in instalments]:”
The purpose of the suggested orders are to provide some protection to the Wife where she has no control over how the payment will be made. From my perspective, the above orders reduce potential tax risks to the Wife with little extra effort.
However, what about the Husband’s perspective?
If the Husband has funds outside of his entities from which he plans to make the payment, then there may not be any tax issues to consider from his perspective. However, if the Husband’s only source of funds are in his company, then using those funds to make the payment could cause him a tax liability. This liability could be for the current financial year or spread over future years. This would depend on the specific circumstances.
If the Husband is going to incur a tax liability to make a payment required by the orders, he may wish to obtain evidence to support both the amount and timing of the tax liability. This would assist in supporting any arguments he wishes to make that the tax liability should be taken into account when determining the parties’ net assets.
Regardless of whether he wants the tax liability to be taken into account, if you have concerns he could incur a tax liability I would suggest that you advise your client to obtain advice from their accountant before the orders are finalised.
In addition to considering tax, when a party is going to receive a payment or make a payment that will result in a tax liability, be mindful of any impact on government benefits and child support. An increase in their taxable income could also have an impact on the amount of such benefits or their obligation to pay such benefits.