When a Marriage Ends, the Tax Bill Doesn’t: A Guide for Australian Business Owners

Prepared by Saby MGA Audit

Family lawyers settle property in round numbers – 60/40, an even split, “she keeps the business, he keeps the house.” The Australian Taxation Office has never understood that vocabulary. It thinks in capital gains, deemed dividends, resettlements and forfeited concessions, and it tends to arrive with its invoice months after the consent orders are signed, the file is closed and everyone has moved on.

For a PAYG couple whose main assets are a family home and two super balances, separation is usually a light tax event. For a business owner it is a different exercise entirely. A founder running a trading company, a family group operating through a discretionary trust, a bucket company sitting on years of retained profits – for these clients, the tax triggered by the split can be worth more than the concessions the parties are actually arguing about across the negotiating table. We have reviewed settlements where tax quietly stripped out more than twenty per cent of the pool.

What follows is not legal advice, and it is not a commentary on the Family Law Act. It is written from the tax side of the table, for the people whose signatures end up on the returns.

The problem in one sentence: every transfer is a taxable event waiting to happen

A property settlement is not a single transaction. It is a chain of them, and almost every link can trigger tax.

Moving an asset can crystallise a CGT event under Part 3-1 of the Income Tax Assessment Act 1997. Paying money or transferring property out of a private company can activate Division 7A of the Income Tax Assessment Act 1936. Touching a discretionary trust can cause a resettlement, a family trust distribution tax charge, or both at once.

Here is the point clients most often miss: the Family Law Act decides who receives what. It has nothing to say about who carries the tax. That is governed by legislation no family court can override – and, just as importantly, by choices made or missed in the weeks before the orders are drafted.

Subdivision 126-A: relief that defers, never relief that forgives

The marriage and relationship breakdown rollover in Subdivision 126-A of the ITAA 1997 is the most valuable provision in this whole area, and the one we most often see misunderstood.

What it actually does. Where it applies, the rollover switches off the capital gain or loss the transferor would otherwise make. The receiving spouse inherits the transferor’s cost base, and any pre-CGT character of the asset carries across untouched. Crucially, this is a same-asset rollover – it postpones the tax until the asset is eventually sold. It does not erase it. The liability simply changes hands.

When it applies – and when it doesn’t. A rollover is not handed out just because a couple has separated and shaken on a division of assets. Section 126-5 requires the CGT event to happen because of a specific, closed set of triggers: a court order under the Family Law Act, a binding financial agreement, an arbitral award, or an equivalent instrument under State, Territory or comparable overseas law. A private, informal transfer between separating partners – however sincere and however well-intentioned – attracts no rollover whatsoever. This is precisely where value gets destroyed: the shares change hands in March; the orders aren’t made until November; the gain is fully assessable in between.

Companies and trusts. Section 126-15 stretches the rollover to cover transfers from a company or trust to a spouse or former spouse. Note the direction. It runs one way only. Moving assets into an entity – say, restructuring property into the retaining spouse’s new holding company as part of the deal – sits outside the rollover entirely.

It happens automatically. When the conditions are satisfied, the rollover simply applies. You cannot elect out of it. That is a genuine trap where one spouse is holding unused capital losses and would actually prefer to trigger a gain to soak them up. If that’s the goal, it has to be engineered into how the transaction is structured – there is no opportunity to opt out after the fact.

The main residence catch. When a dwelling moves under the rollover, section 118-178 requires the receiving spouse’s main residence exemption to be calculated by reference to both parties’ use of the property over time. A home that spent its first eight years as an investment in one spouse’s hands does not magically become fully exempt once it lands in the other’s.

Division 7A: the landmine buried in the loan account

Subdivision 126-A offers no protection against Division 7A. None.

Where a private company transfers an asset to, or meets a payment for the benefit of, the spouse who is not a shareholder, that spouse is almost always an associate of a shareholder. Section 109C of the ITAA 1936 can then recast the transfer as an unfranked deemed dividend, to the extent the company has a distributable surplus. The ATO’s stance leaves no room for hope: in TD 2014/1 the Commissioner confirmed that a payment or transfer a private company makes to comply with a section 79 Family Court order is still a payment for Division 7A purposes.

That bears repeating. A court order forcing the company to hand over an asset does not shield the recipient from a deemed dividend – taxed at their marginal rate, with no franking credit to soften it.

And that is before you reach the balances already sitting on the books. Most owner-managed groups carry director loan accounts and unpaid present entitlements. On separation, every one of them has to be found, valued and allocated. The failures we see most often:

• Overstating the pool by treating a Division 7A loan balance as a clean asset, without discounting it for the tax cost of actually pulling the cash out to repay it.
• Forgiving a spouse’s loan account as part of the settlement – which can spring a deemed dividend under section 109F, or bite under the commercial debt forgiveness rules in Division 245 of the ITAA 1997.
• Letting a complying section 109N loan slip into default in the year of separation, simply because nobody is watching the group’s compliance calendar while the relationship falls apart.
• Funding the payout through a share buy-back without first modelling the dividend component under Division 16K of the ITAA 1936.

Section 109RB does hand the Commissioner a discretion to overlook a deemed dividend caused by honest mistake or inadvertent omission. Treat it as an emergency exit, not a strategy.

Trusts: the immovable object in the family group

The discretionary trust is the standard vehicle for Australian family businesses, and it is also the hardest asset to move in a separation.

Dividing one is seldom as simple as redrafting the deed. Depending on how the change is executed, a variation can trigger CGT event E1 or E2, and splitting a trust – or carving out separate funds within an existing one – may be treated as bringing an entirely new trust into existence. The ATO’s positions on trust variations and trust splitting need to be worked through in detail before anyone puts a pen near the deed.

The subtler danger is the family trust election. Once a trust has made one, any distribution outside the family group of the nominated individual is hit with family trust distribution tax – the top marginal rate plus Medicare levy – under Schedule 2F to the ITAA 1936. The problem is that when a marriage or relationship ends, a former spouse drops out of the family group for any distribution made afterwards. A trust that has paid a spouse and the spouse’s parents comfortably for fifteen years can turn into a compliance hazard the moment the relationship is over. Schedule 2F does allow the nominated individual to be varied following a breakdown, but the window is narrow, it is time-limited, and it is regularly overlooked.

Small business CGT concessions: use them or lose them

Division 152 of the ITAA 1997 is capable of wiping out or deferring the tax on a business exit altogether – through the 15-year exemption in Subdivision 152-B, the 50% active asset reduction, the $500,000 lifetime retirement exemption in Subdivision 152-D, and the replacement asset rollover.

Separation undermines every one of these, because they all rest on relationships that a divorce dissolves:

• The $6 million maximum net asset value test in section 152-15 pulls in the net assets of connected entities and affiliates – and a spouse’s assets are dragged in through the affiliate and section 152-47 rules.
• The significant individual and CGT concession stakeholder tests in Subdivision 152-A hang on ownership percentages that the settlement is about to rewrite.
• The active asset test depends on ownership periods, which a transfer can reset or cut short.
• The 15-year exemption requires 15 years of continuous ownership plus a qualifying event, such as retiring after 55 – so a transfer in year 13 is a very expensive way to throw away a full exemption.

Sequencing decides the outcome. Whether the business is sold before or after settlement, and by whom, can be the whole difference between a gain that is fully exempt and one that is fully assessable.

Superannuation, duty and the value of latent tax

Superannuation splitting under Part VIIIB of the Family Law Act is broadly tax-neutral at the moment of the split, but the flow-on effects are not: transfer balance cap positions shift, the in-specie transfer of business real property out of an SMSF has to be handled carefully, and contribution capacity that had been set aside for a small business CGT contribution can be lost.

Duty relief for transfers between spouses under court orders or binding financial agreements exists in every State and Territory, but the conditions vary and none of it is automatic. Check the position under the relevant State legislation before the orders are drafted – [Placeholder: relevant State/Territory duty provision].

Finally, the latent tax point. Where an asset carries an embedded CGT liability, the Family Court may – depending on the circumstances and how likely realisation is – factor that liability into the value of the pool: see Rosati v Rosati (1998) FLC 92-804. But that argument only carries the weight of the analysis behind it. A properly modelled deferred tax position, prepared by a tax specialist, is evidence. A vague assertion that “there’ll be CGT to pay one day” is not.

The traps we see most often

The order of operations

The sequence that preserves value is remarkably consistent across the matters we advise on:

1. Map the structure – every entity, every loan account, every unpaid present entitlement, every election – before anyone takes a position.
2. Quantify the latent tax in each asset, so the pool is negotiated on after-tax values rather than headline figures.
3. Model at least two settlement structures against the tax outcome, not just the family law outcome.
4. Draft the transfer mechanics so the Subdivision 126-A conditions are met and Division 7A is managed rather than discovered later.
5. Deal with the concessions – Division 152 eligibility, superannuation caps, franking balances – before the structure changes, not after.
6. Document the post-settlement compliance obligations and allocate them to a named party in writing.

Steps one to three belong before your family lawyer drafts the orders. Every week you wait closes off options.

The takeaway

For a business owner, the difference between a well-structured settlement and a poorly sequenced one is rarely found in the percentage split. It is found in the order the transactions happen, the timing of the court orders relative to the transfers, and whether anyone modelled the Division 7A and CGT consequences before the deal was locked in rather than after.

The lawyers negotiate the split. Someone still has to sign the returns. If you are approaching a separation and your wealth sits inside a company, trust or family group, bring your tax adviser into the room while the deal can still be shaped – not once the orders are sealed and the only remaining question is who pays.

Saby MGA Audit works alongside business owners and their legal advisers to model the tax consequences of a separation before settlement terms are finalised. This article is general information only and does not constitute tax, legal or financial advice. Speak to a qualified adviser about your specific circumstances.