ATO draft ruling on Division 7A exclusions creates headache for spouses who receive payments from private companies under terms of matrimonial property settlements

14 January 2014 Topics: Family law, Tax and revenue

The Australian Tax Office (ATO) has issued draft ruling TR 2013/D6 clarifying its view on the application of section 109J of the Income tax Assessment Act 1936. The views in the draft ruling conflict with some previously issued private rulings and Interpretative Decisions.

Background

It is common in family law settlements where one party has a controlling interest in a company for the property settlement to involve a payment or transfer of property from the company to the other spouse.

ATO position in private rulings

In a private ruling (number 85828) the ATO had indicated that such an arrangement would not trigger a deemed dividend under Division 7A because the payment was made to discharge the financial obligation imposed by the court order and was therefore within the scope of the exemption in section 109J.

Under Section 109J, payments made by a private company are not taken to be deemed dividends under Division 7A to the extent that the payment:

  • discharges an obligation of the private company to pay money; and
  • is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm’s length.

The obvious advantage of this interpretation was that the payments would not be taxable as a deemed dividend under Division 7A (although the payment may still have been treated as a dividend under the general provisions in the Act if the recipient spouse was a shareholder at the time of payment).

The revised interpretation – TR 2013/D6

In TR 2013/D6 the ATO has reversed its position and indicated that a payment from a private company to a spouse pursuant to a court order will not satisfy the requirements for exemption under section 109J and will be a deemed Division 7A dividend.

This draft ruling reflects the views in a more recent private ruling (number 1012508158267).

The basis of the revised view is that the ATO considers the second requirement of section 109J is not satisfied, because the payment will generally be more than would have been required to discharge the obligation had the parties been dealing with each other at arm’s length.

In the context of a property settlement, the ATO considers that:

the parties are not dealing at arm’s length; and

had the parties been dealing at arm’s length, the company would not have made a ‘gratuitous’ payment.

What this means

The consequences of this draft ruling are significant. As the Division 7A exemption is no longer available, parties will need to reassess their capacity to finance payments from related companies.

It may mean, for instance, that parties need to adjust their expectations and consider staged payments, accepting that some portion of the settlement will be paid as taxable dividends or adjusting the quantum of the financial settlement to reflect the potential tax consequences.

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