As discussed in some of our previous articles (see Tax relief for matrimonial breakdown – what are the requirements and Matrimonial breakdowns – is CGT relief available on the transfer of assets to trusts or companies?), CGT relief under Subdivision 126-A of the Tax Act 1997 is usually available in respect of the transfer of assets between spouses following a matrimonial breakdown.

One issue which is commonly overlooked by advisers is that Subdivision 126-A is a tax roll-over and not a tax exemption.

This means that where the provisions are applied, the recipient of the asset inherits the transferor’s tax cost base for the asset and will be liable for CGT on any inherited capital gain.

The contrast between a CGT exemption and a CGT roll-over (and the potential pitfalls for family law advisers) can be illustrated with the following example:

• Bob and Bindi own two properties – an investment property acquired for $250,000 and currently valued at $600,000 and their family home acquired for $400,000 and currently valued at $600,000;
• Bob and Bindi suffer a relationship breakdown. They agree to separate their assets and enter into a binding financial agreement (BFA) pursuant to which Bob receives the investment property (valued at $600,000) while Bindi retains the family home (also valued at $600,000);
• Bob and Bindi have each received an asset valued at $600,000 and appear to have been treated equally under the BFA;
• One year later, each of them decides to sell the property they received in the relationship breakdown to acquire a new home;
• When Bindi disposes of the family home, she is eligible for the main residence exemption and receives the entire $600,000 capital proceeds tax free; and
• By contrast, when Bob sells the investment property, he is advised that the CGT roll-over under Subdivision 126-A means he inherited the previous $250,000 cost base for the property. When he sells the property for $600,000, he incurs a $350,000 capital gain and is liable for approximately $85,000 in tax.  This means he ultimately only has $515,000 to invest in a new property, compared to Bindi’s $600,000.

Inevitably in the circumstances above, Bob’s original advisers will be under scrutiny if they had not identified and explained the potential future tax cost to Bob, when the BFA was being negotiated.

Alternative approaches would include:

• structuring the disposal of the investment property of Bob in a manner which did not qualify for the roll-over in Subdivision 126-A; or
• including a cash adjustment between Bob and Bindi in the binding financial agreement, to compensate Bob for the future tax payable on a disposal of the property.

While this still would have resulted in an $85,000 tax bill being triggered, the tax cost could then have been factored into the commercial negotiations between the parties and the tax liability potentially split equally between Bob and Bindi.

The example highlights the importance of ensuring that all parties are aware of their likely future tax position and not just the immediate consequences of a matrimonial breakdown.

For further information, please contact Patrick Ellwood on 0400 503 111 or patrick@cloverlaw.com.au.

• CGT
• clover law
• matrimonial breakdown
• Tax Law