Tax Traps

The tax system is full of traps. One of those traps is that if a company pays money or transfers property to a shareholder or a shareholder's associate, that can be deemed to be a dividend and taxable in the hands of the person who receives it.  An associate would include a spouse.  This happens under the "deemed dividend" provisions of Division 7A of the Income Tax Assessment Act.

On 30 July 2014 the Tax Office released a ruling about this. Up until that ruling, we had all thought, and acted on the thought that if money was paid or property transferred to a shareholder or a shareholder's associate by means of Family Court orders or financial agreements, it would not be taxable because of the family law exemption.  The new ruling turns this on its head.  Those transfers or payments are now taxable.

The new ruling is a major shift in the ATO's previous position and provides, in effect, that where a Family Court order requires a private company or a party to the proceedings to cause a private company, to pay money or transfer property to a shareholder, that payment or transfer is an ordinary dividend to the extent that it is paid out of the private company profits, and is assessable income of the the shareholder.

Similarly, any payment of money or transfer of property to an associate of a shareholder in compliance with an order is also a payment for the purposes of Section 109C(3) of the ITAA and treated as a dividend.

The Tax Office has previously said it will not undertake active compliance activities on payments of this nature prior to publication of the draft ruling in November 2013.  However it is important to note that new ruling operates retrospectively, with limited exception in relation to orders made prior to the new ruling.