The Tax Cost of Relationship Property Settlements

 
Grange Associates Ltd - 11 May 2012

The Income Tax Act 2007 (‘the Act’) contains a number of concessions that apply when property is transferred as a result of a relationship/matrimonial separation. Basically, the concessions allow property that would otherwise give rise to a tax liability upon transfer, to be transferred tax-free. This outcome typically occurs by deeming the recipient of the property as having stepped into the shoes of the other party. Further down the track, when the recipient sells the property the relevant tax outcome would arise at that time.

Examples of property where the concessions apply include trading stock, bloodstock, depreciable property, livestock, timber, land and a look-through interest in a look-through company.

The concessions in the Act relate to transfers of property made pursuant to a “relationship agreement”, which simply put, is defined as “an agreement for the purpose of Part 6 of the Property (Relationships) Act 1976” or “an order under section 25 of the Property (Relationships) Act 1976”.

Part 6 of the The Property (Relationships) Act 1976, enables the parties to a relationship to contract out of the provisions of that Act. Similarly, an order is made in respect of property. Because the relevant sections of the Property (Relationships) Act relate to property of the individuals, property held by other entities such as companies or trusts may not be covered. This arguably limits the tax concessions applicable to transfers of property between the individual members of the relationship. For example, the concessions could apply to shares held by the individuals in a company, but not to the underlying assets of the company.

It is important that the tax cost of transferring property not subject to the concessions is identified and taken into account when deciding how assets should be divided, for example the tax cost could be factored into the property’s value. Alternatively, a tax neutral method of transferring the property may be available, such as structuring a transfer to allow other general concessions to apply (such as the wholly-owned group dividend exemption). Tax avoidance implications would need to be considered and ruled out in this type of scenario.

In extreme cases, one of the parties may be willing to bear the tax burden so they can separate and move on with their life. However, it will be cleaner and cheaper to know up-front whether the concessions apply and to plan ahead accordingly.

While the existence of the concessions is relatively well known, the risk that the concessions do not apply to third party property is sometimes overlooked. The realisation that a tax cost could apply to property transfers can exacerbate an already difficult situation, whether it is before, during or after a settlement is reached.

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