Transferring tax liabilities between spouses in family law proceedings

Transferring tax liabilities between spouses in family law proceedings

In the 2017 case of Tomaras & Tomaras and Anor and Commissioner of Taxation [2017] FamCAFC 216 the Full Court of the Family Court of Australia has stated that section 90AE of the Family Law Act empowers the Family Court to make orders as part of a property settlement requiring the Commissioner of Taxation to substitute for one person who has a tax liability owed to the Commonwealth to another person.

The case involved a wife seeking an order that the husband be substituted for her as the party liable to meet a taxation debt to the Australian Taxation Office.

The Full Court determined that that the Commissioner of Taxation is a creditor for the purposes of section 90AE.

The facts

The husband and wife were married in 1992 and separated in 2009. During their marriage, the Commissioner issued assessments requiring the wife to pay income taxation and the Medicare levy. The wife failed to pay the amounts assessed, while also failing to lodge any objection.

In November 2009, the Commissioner of Taxation obtained a default judgment against the wife for the unpaid tax and the penalties incurred. She failed to pay the judgment debt, and the Commissioner of Taxation did not take any steps to enforce it.

In November 2013, the husband became bankrupt. It is common ground that nothing turns on this for purpose of the proceedings.

In December 2013, the wife commenced proceedings in the Federal Circuit Court, seeking orders for property settlement. In February 2016, the Commissioner of Taxation was given leave to intervene in those proceedings.

By her amended application in the Federal Circuit Court proceedings, the wife sought the following order:

Pursuant to section 90AE(1)(b) of the Family Law Act 1975 (Cth), in respect of the applicant wife’s indebtedness to the Commissioner of Taxation for the Commonwealth of Australia taxation related liabilities in the amount of $256,078.32 as at 9 August 2016 plus General Interest Charge (GIC), the respondent husband be substituted for the applicant wife as the debtor and the respondent husband be solely liable to the Commissioner of Taxation for the said debt.

On 22 August 2016, Federal Circuit Court asked for the opinion of the Full Court of the Family Court of Australia in the following terms:

Does section 90AE(1)-(2) of the Family Law Act 1975 (Cth) grant the court power to make Order 8 of the final orders sought in the amended initiating application of the Wife?

The decision

The Full Court responded:

Yes, but with the proviso that sction 9OAE(1) confers power only to make an order that the Commissioner be directed to substitute the first respondent for the applicant in relation to the debt owed by the applicant to the Commissioner of Taxation for the Commonwealth of Australia

The objection of the Commissioner of Taxation

A question arose in the proceedings as to whether the Crown was bound by section 9OAE.

The Commissioner of Taxation contended that section 9OAE did not bind the Crown insofar as taxation debts were concerned. The Full Court rejected the Commissioner of Taxation’s argument.

In reaching this conclusion, the Full Court found that it could only be reasonably argued that s 90AE can only impose a benefit on the Crown since:

1. instead of a less wealthy taxpayer being responsible for a tax liability, his or her wealthier spouse may be made solely responsible pursuant to section 90AE(1)(a), thereby increasing the prospects of recovery;
2. instead of one spouse being responsible for a tax liability, both spouses may be made liable pursuant to section 90AE(1)(b), thereby providing a remedy for recovery that otherwise would have been unavailable;
3. whilst an order might be made leaving the less wealthy spouse to meet a tax debt, such an order could not be made if it was foreseeable that the order would result in the debt not being paid (section 90AE(3)(b)); and
4. the legislation permits the court to make such order as it considers just for the payment of the reasonable expenses of the creditor incurred as a necessary result of the order (section 90AJ(2)).

Special leave was granted for the Commissioner of Taxation to appeal the decision to the High Court on 23 March 2018.

What are the consequences?

The Full Court found that section 90AE can be applied to substitute one taxpayer for another and that such order is binding on the Commissioner of Taxation.

When making an order for substitution, the court must consider the prospects of recovery of the debt from the substituted party.

In the case of a wealthier spouse who allocates income to his or her spouse through trust distributions and where this gives rise to a taxation liability where no provision for the payment of the tax was made it allows for Orders to be sought protecting the less wealthy spouse.

The decision has beneficial implications for the less wealthy spouse who may carry the risk of an income tax liability created for the benefit of their wealthier spouse following the breakdown of their relationship.

As family lawyers, we are not qualified to provide you with taxation advice. We are, however, required to understand the potential tax consequences of property settlements. It is extremely important that you have a specialised family lawyer who can identify these taxation issues and work with you and your accountant to achieve you the most tax effective and beneficial outcome for you from your property settlement.

If you have any further questions relating to tax and its impact in a property settlement please contact us.