Problems with Property Settlement: 1. Division 7A Income Tax Assessment Act
When I was a junior solicitor many years ago, I was staggered to see that private companies lent money to their directors and shareholders, which was never repaid, and for which no tax was paid by the directors and shareholders. I wondered how this could happen. Well of course it was a loophole, and was often used.
Then in 1997 this all came to an end with the enactment of Division 7A of the Income Tax Assessment Act, which deemed these payments to be dividends, on which tax was payable in the hands of those receiving them.
Naturally, there was an exception, and that was no surprise- if companies lent to their shareholders/directors on commercial terms, then subject to the guidelines of the Australian Tax Office, those payments were loan amounts and were not subject to the deemed dividend provisions of division 7A.
Why this is relvant to family law
Experienced family lawyers like me know that the way of solving clients’ problems is usually not to act alone, but as part of a team that can help the client.
When looking at balance sheets of the family companies, it is important to identify if there are any loans outstanding to family members. if there are, it is necessary to identify if the loans are commercial within the ATO guidelines- otherwise there may be a large amount of tax payable.
It is usually at about this point (if it hasn’t happened sooner) that I call in the experienced chartered accountant, who is able to tell me what problems there might be with this company, including what Division 7A pitfalls there might be, and how to fix them. The latter might occur, for example, by the company formally declaring a dividend, and then crystallising the tax paybale by the parties.
This obviously requires some co-operation on the part of both parties, as it’s not something that would be ordered by a court. Why should a court be involved in tax planning for the parties? That’s their responsibility, not the court’s.
It is essential to be able to identify if a potential Division 7A problem may exist. Too late, and your client might have to pay substantial tax- and then come after the lawyer who persuaded him or her to enter into the deal, but didn’t warn of potential tax problems.