The ATO has made its final ruling on the application of Division 7A to relationship breakdowns.
If a private company is ordered by the family court to make a payment or transfer an asset to a separating partner, then the settlement will be treated as a distribution of profits for tax purposes.
The ruling has also clarified that the marital party will be treated as a shareholder for tax purposes, meaning that they will be able to access franking credits where applicable.
Division 7A of the Income Tax Assessment Act 1936 (ITAA) has been designed to ensure that private companies cannot distribute funds to shareholders, or parties related to shareholders, to avoid a tax liability. Under Division 7A when a shareholder or associated party is given a payment or has a debt forgiven by a private company, the amount is considered as a dividend for tax purposes and is taxed at the individual’s marginal tax rate.
The ATO ruling, therefore, has increased the likelihood of negative tax implications for separating partners receiving a payout from a private company.
In the event that a family court order requires a private company to transfer property to a matrimonial party, the transfer will result in a matrimonial deemed dividend, and the private company will be able to defer the capital gains tax liability until the marital party decides to sell the property.
The ATO has acknowledged that this ruling is contradictory to a large number of previous private rulings and interpretive decisions. It has also been indicated that the ATO will not seek to review any of its past decisions pertaining to marital breakdown and division 7A. However, any matters that are brought to the ATO as of 30 July 2014 will be considered in line with the most recent ruling.