Relationship property settlements and tax refunds
||As family lawyers, we are often privy to our clients’ “Woo Hoo” moments well before anyone else is, and tax-time is no exception.
- By Sharon Bennett, Barrister
When negotiating relationship property settlements, it is important to bear in mind potential tax windfalls and latent tax liabilities that can occur on the transfer of property ownership between spouses.
Bells should ring when dealing with settlements involving the transfer of shares in family-owned companies or highly geared investment properties. At face value the property may seem to be of little value. However, the cash-flow implications of a significant Working for Families tax credit, or the sad news that inadequate PAYE deductions or depreciation claw-back have destroyed any chance of a tax refund, can make all the difference to the part-time working mother awaiting her final property settlement or the cash-strapped leaky-home owner. A simple call to the accountant could be worth its weight in gold.
The transfer of property between spouses under a formal separation agreement or court order is generally tax neutral. The intended effect is that the transferee steps into the shoes of the transferor for tax purposes. Although not an exhaustive list, the examples below highlight some of the potential exceptions to this concession and the areas where there are opportunities to add value for your client, either by negotiating a better settlement price, or working with their advisor on ways in which they can access their tax assets before kissing them goodbye:
- Transfers of property are made from or to a family trust or other non-natural person.
- Un-used tax credits or losses are available for future use by the recipient.
- A business asset is transferred to someone who will no longer be running that business.
The recipient partner can unwittingly inherit a latent tax liability or tax benefit, which will affect his or her tax position in the future.
Tax losses and imputation credits when family businesses change hands
For owner-operated trade-type businesses, it is quite common to see a “running down” of the value of the business just prior to separation and, in many cases, a previously profitable business showing a trading loss. While a formal business valuation may not appear to be justified for relationship property purposes, it is well to remember that the outgoing partner may be leaving behind quite valuable tax assets in the form of carry-forward tax losses and imputation credits, effectively leaving tax-paid profits for the remaining partner to use in future years.
For an outgoing shareholder on a low marginal tax rate, it may be worth making a special imputed dividend distribution prior to the transfer to ensure that he or she gets the benefit of those tax concessions.
Working for Families tax credits – minimum tax credit
Working for Families tax credits include a minimum tax credit of $437 per week where a person’s net family income from salary or wages is $22,724 or less for the year ended 31 March 2014.
The refund is also available to shareholders of certain family-owned companies, or “close companies”, when that shareholder works for 30 hours or more per week.
For partners who have been working for the family business (say, in the capacity as bookkeeper or other role), it is important that they can point to an employment arrangement and the receipt of salary and wages (as opposed to drawings and/or dividend income) in order to claim this credit.
When calculating the net family income, losses from certain business and investment activities are now excluded, and income from trustee-owned assets are included.
A potential pitfall occurs when the property settlement involves the transfer of a building or other business asset that has had depreciation claimed against it in prior years. The asset is treated as having been transferred for its original cost and the transferee takes over any depreciation claimed by the transferor on that asset. This can leave a latent tax liability to the transferee.
Christine and Pete have separated after a 15-year marriage. They own a home in Grey Lynn, from which Pete has been running his medical practice. They enter into a separation agreement on 1 September 2012 which transfers Pete’s share in the home to Christine. They do not bother getting a valuation, and instead use the written-down value of the building from Pete’s practice accounts. From 1 April 2013, Christine will be potentially responsible for tax on depreciation-recovered income that has been claimed over the years if the market value is more than its original cost. This is because there has been a change of use in the previous year, ie, taking the home from a business purpose to a private one.
When drafting a separation agreement or contracting agreement it is wise to consider including a clause that clarifies who is to carry any future tax consequences as a result of the agreement. It is also helpful to ensure that adequate value is placed on the tax benefit being passed on to the recipient.
Sharon Bennett is a family law barrister with a taxation, banking and finance and general management background. Sharon specialises in relationship property, trusts and succession planning. Before joining the family law bar, Sharon was the Managing Director of Lexis Nexis New Zealand and Managing Director of CCH New Zealand and CCH Australia Publishing.