Emmerton & Manwaring [2023] FedCFamC2F 476: dealing with debt loan accounts and Div 7A

Division 7A of the Income Tax Assessment Act 1936 is an anti-avoidance provision that is often overseen in family law matters.?Being mindful of a potential Div 7A issue when structuring payments or transfer of property - whether that be by way of spousal maintenance or under final property orders, or an in-specie transfer of property whilst utilising s 90AE of the Act – is part of a family lawyer’s toolkit.?It is then a matter for tax lawyers and accountants to provide necessary assistance in relation to the potential tax payable by the husband or wife on the payment or transfer of property from a company.?I do not intend to work through the relevant provisions of Division 7A of Part III of the ITAA 1936 other than to say these are expressed in Taxation Ruling 2014/15: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate).

Occasionally, family law matters are troubled by concerns regarding company loan account debit balances, whether a compliant loan agreement (s 109N) has been executed for the purposes of Div 7A and then whether corrective action (s 109RB) can be taken to remedy a breach. There is also the issue of cleaning up loan accounts and the taxation consequences thereto must be factored into the overall outcome.?In Emmerton & Manwaring [2023] FedCFamC2F 476 an issue between the parties was the husband’s drawing down on cash from the B Pty Ltd (a family company) and debiting the loan account.

The brief facts in Emmerton were as follows:

1.????The parties were in a lengthy marriage of 28 years.?The parties were able to acquire significant assets through the acquisition of real property, the source of the wealth being B Pty Ltd, the family business in which they both worked.?B Pty Ltd was a business that manufactured building products.?The husband was the sole director of B Pty Ltd, whilst both parties held equal shares.?

2.????The wife’s complaints were that the administration of the B Pty Ltd was in ‘disarray’.?The parties and B Pty Ltd incurred tax liabilities and gained the attention of the Deputy Commissioner of Taxation with whom B Pty Ltd (and other entities) had reporting obligations.?

3.????During the proceedings, the top up tax liability issue arose.?Judge Boyle made procedural orders that:

The parties and Counsel properly instructed for Mediation meet with [Mr R] of [Firm S] at their joint expense to receive advice as to any Division 7A Loan implications.

The Div 7A issue

1.????Mr R indicated that the Div 7A loan would crystalise when B Pty Ltd lodges its relevant tax returns.?The trial judge criticised the parties as to why the tax returns had not been completed. ?In any case, Mr R provided a report, noting that he had company accounts up to 28 January 2022, but could not assert to their accuracy or completeness.?

2.????The question posed to Mr R was “What is the quantum of the parties’ potential Division 7A liability?”?In reply, noting that the judgment did not identify the deemed unfranked divided, Mr R opined:

Applying an average marginal tax rate of 34.5% across all years, an estimate of the Division 7A loan balances and potential tax payable of each balance being assess as a deemed unfranked dividend [table removed].

Mr R also opined that the debt had crystalised and that there should be a referral to a tax lawyer for assistance as to whether corrective action could be taken.?However, His Honour said that, for the purposes of determining whether the tax liability should be identified in the pool of assets divisible between the parties:?“in my view, there is a lack of certainty regarding the overlap between the parties’ potential liability for Division 7A tax…”

3.????In this regard, consistent with the authorities regarding debts uncertain or contingent, the court said:

At [110]:??????????‘the Court is not obliged to include an uncertain or imprecise liability. This is the central issue in the current matter, centring as it does on the uncertainty surrounding the Division 7A loans owed to B Pty Ltd and other of the husband’s tax liabilities.’

At [133]:??????????In the present matter, although the exact quantum of the Division 7A debts is vague, it seems improbable that their operation will not be enforced, at some stage, by the ATO. I also concede that it is far from clear, given the not inconsiderable period since the parties separated, how the ATO will approach the loans owed by each of the parties concerned to the business.

What then?

His Honour, then, in the absence of having some idea as to the quantum of the tax debt stemming from the Div 7A issue, was not prepared to make final orders.?In this regard, His Honour said: ?“it is my provisional view that I require more detailed evidence regarding the extent of the parties’ joint and individual liabilities to the ATO before it can be determined in what proportions the parties’ existing assets should be divided.”?His Honour went on to say that:?“It would be my preference that this evidence is available concurrently with the parties’ final written submissions and perhaps within the context of an agreed balance sheet of assets and liabilities.”

Orders made on the Div 7A issue

The court then made the following interim orders relevant to the issue - with a view to the parties jointly approaching the ATO to determine with precision their tax liabilities and the most effective way to pay it:

1.????That within 21 days each party do instruct their accountant, as soon as is practicable and in any event within 14 days, to advise the Australian Taxation Office of their personal non-current and non-compliant Division 7A loan balances within B Pty Ltd

2. All correspondence between the ATO and the parties (and/or their advisors and solicitors) be in writing and the solicitors for the other party be copied into that correspondence.

3. The husband be restrained and an injunction be granted restraining the husband from making drawings that impact on any current and future Division 7A loans from the business B Pty Ltd.

END