Uncrystalised Capital Gains Tax – is it part of the pool?

What is capital gains tax?

Capital Gains Tax (CGT) is a tax on the profit realised on the sale or transfer of assets, including for example, an investment property or shares.

A capital gain occurs when the sale price of a capital asset is greater than the cost of the asset. For example, if an investment property was purchased for $600,000 and later sold for $900,000, the capital gain is $300,000. Certain deductions may be made when calculating capital gain such as the cost of sale. The taxpayer is required to record their capital gain on their tax return for the relevant financial year, and that capital gain may be subject to CGT.

It is always advisable to speak to your accountant to obtain advice about what your capital gain is what the CGT consequences on sale of that asset are likely to be.

Why is capital gains tax relevant in a property settlement?

Capital Gains Tax (CGT) applies to any change of ownership of an asset unless an exemption applies.

The two relevant exemptions are:

1. Main residence exemption;
2. Roll-over relief

Main residence exemption

CGT does not apply to the transfer of a family home from one spouse to the other, because of the main residence exemption, which states that no CGT will be payable on the profit.

Roll-over relief

If you transfer an asset (usually an investment property) to your spouse/de facto partner because of the breakdown of your marriage or relationship, there can be an automatic rollover of the asset.

Following breakdown of a married or de facto relationship, if you transfer an asset from one party of the relationship to the other pursuant to a court order or financial agreement, you can obtain rollover relief, meaning that CGT is not payable on transfer of the asset to your former partner: section 126 Income Tax Assessment Act 1997 (Cth).

‘Rollover’ means the transferor spouse disregards the capital gain or loss that would otherwise arise.

In effect, the person who receives the asset (the transferee spouse) will make the capital gain or loss (and if it is a capital gain, they will be responsible for payment of CGT) when they subsequently dispose of the asset. The cost base of the asset is also transferred to the transferee spouse.

CGT rollover applies only if:

1. the asset or share of an asset is transferred between you and your spouse or from a company or trust to one of you;
2. The transfer of ownership is because of a court order, formal agreement or award.

You can’t choose whether or not the rollover applies.

The Full Court decision in Ellison & Sandini makes clear that CGT rollover relief on relationship breakdown is only available for transfers to a party to the relationship and not to a trust or other related entity which the party has effective control of.

How is Capital Gains Tax taken into account in a property settlement?

When determining the asset pool in a property settlement matter, the Court can take into account any capital gains tax implications that may arise in relation to the disposal of assets which may occur, such as an order to sell an investment property neither party wishes to retain.

The leading case of Rosati makes clear the following principles that are relevant when assessing the relevance of CGT and whether the asserted CGT liability that has not yet crystalised, should be included in the property pool:

1. Whether the incidence of CGT should be taken into account in valuing a particular asset varies according to the circumstances of the case, including the method of valuation applied to the particular asset, the likelihood or otherwise of that asset being realised in the foreseeable future, the circumstances of its acquisition and the evidence of the parties as to their intentions in relation to that asset.
2. If the Court orders the sale of an asset, or is satisfied that a sale of it is inevitable, or would probably occur in the near future, or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then, generally, allowance should be made for any capital gains tax payable upon such a sale in determining the value of that asset for the purpose of the proceedings.
3. If none of the circs referred to in (2) applies to a particular asset, but the Court is satisfied that there is a significant risk that the asset will have to be sold in the short to midterm, then the Court, whilst not making allowance for the capital gains tax payable on such a sale in determining the value of the asset, may take that risk into account as a relevant s 75(2) factor, the weight to be attributed to that factor varying according to the degree of the risk and the length of the period within which the sale may occur.
4. There may be special circumstances in a particular case which, despite the absence of any certainty or even likelihood of a sale of an asset in the foreseeable future, make it appropriate to take the incidence of capital gains tax into account in valuing that asset. In such a case, it may be appropriate to take the capital gains tax into account at its full rate, or at some discounted rate, having regard to the degree of risk of a sale occurring and/or the length of time which is likely to elapse before that occurs.” Whether CGT will be taken into account in calculating the net asset pool will depend upon the circumstances of that individual case.

Importantly:

• The longer the property is to be held the less likely any accrued but uncrystalised liability will be taken into account due to flux of tax laws and the uncertainty of the method and place (eg outside Australia) of disposal and whether there will be a CGT liability: Carruthers Case
• The Court may also consider that the asset holder is the type of person who will try to arrange his/her affairs to minimize tax
• If the tax consequences are purely speculative, they are likely to be ignored by the Court.

It is important that you receive advice in relation to Capital gains tax so you can present a clear picture to the other party’s solicitor and the Court about the impact of the Capital gains tax upon you.

This would include evidence from your accountant as to what the Capital gains tax is going to be.

Recent Case Study: Marlin & Henson

In Marlin & Henson, the Husband appealed final property orders asserting amongst other things, that the Trial Judge failed to include potential Capital Gains Tax in the property pool, in the amount of $3.4M as determined by a joint expert.

The assertion by the Husband was that the primary judge should have taken into account the potential capital gains tax liabilities given:

1. Pursuant to Rosati, the properties were acquired as investments and so it was mandatory for the primary judge to take into account their corresponding Capital gains tax liabilities;
2. His assertion in his oral evidence that he would be required to sell particular properties to make good an order for the payment to the Wife of 20% of the property pool when the judge ultimately ordered that he pay the wife 40% of the property pool. Specifically, his evidence was that he acquired all of his properties as investment properties and that he intended to retire and sell the properties to fund his retirement in 3 – 5 years time.

In the primary judgement, Her Honour made the following comments with respect to the issue of capital gains tax, which the Husband argued on appeal, were wrong:

1. Despite his proposal that an order be made for the Wife to receive 20% of the property pool, he had not proposed any specific real property be sold to facilitate payment of funds to her;
2. Given he had not proposed that real property be sold to enable the payment to the Wife, but instead advanced a case that he be ordered to make such payment in 90 days, teh court could infer that the amount to be paid would be sourced other than from the sale of real property;
3. The court was not persuaded that there was any evidence that the Husband would in fact sell real property to meet his obligations under the judgement;
4. When cross examined, the Husband rejected any suggestion that he transfer certain real property to the Wife, conduct that would in essence defer the crystalisation of CGT and absolve him from the responsibility for the same, in relation to the transferred property.
5. Despite the Husband’s evidence that he could not make a financial payment to the Wife without selling property, the submissions made on his behalf did not specifically seek orders for sale of specified property. Instead, it was contended that if orders were made to adjust the interests of the parties in property to see the Wife receive 20% of the property pool, the appropriate order was that the Husband be required to make such payment within 90 days.

The Appeal Court said that points 1  – 3 were not factual findings made by the Judge but rather a summary of submissions made on behalf of the Husband and points 4 and 5 accurately recorded the Husband’s evidence that he rejected the possibility of transferring properties to the Wife in a manner that would defer the crystallization of capital gains tax liability and that he said he could not make the payment without selling property. The remainder accurately recorded submissions made on the Husband’s behalf wherein he did not seek sale of property by him.

The Appeal Court made findings about the CGT issue, as follows:

1. The Husband submitted to the Court, in effect, that if the Wife received net property of 20% of the pool, he would not be required to sell property to make that payment;
2. The primary judge was not required to find that the 20% further adjustment to the Wife required sale of property by the Husband, absent evidence (and in light of the strong stated position of the Husband that he did not want an order for transfer or sale);
3. The primary judge assessed the credibility of the Husband and did not accept his assertions as to his intentions to sell his properties, both as to his proposed timeframe and as to his intention to liquidate the assets at all. She found that the Husband made representations to the Wife that were inconsistent with his claim to liquidate the properties. She found that the Husband had failed to persuade her that sale was inevitable or likely to occur in the near future, or intended to occur at all. 
4. The strict reading of Rosati as argued by the Husband on appeal that ‘or if the asset is one which was acquired solely as an investment and with a view to its ultimate sale for profit, then generally allowance should be made for any capital gains tax payable on sale’ did not assist the Husband as he failed to make good the necessary facts in relation to the potential disposal of the assets.
5. Rosati is not a code for dealing with potential CGT, rather, Rosati identifies that, in exercising the discretion to include potential CGT liabilities, there is a need to examine the circumstances of the particular case, including as to the prospects of realisation of the assets, the circumstances of the acquisition and the intentions of the parties. Rosati identifies that the greater the certainty and immediacy of a CGT liability, the greater the need to take it into account. This understanding accords with the need, in determining whether an adjustment is just and equitable, to understand the reality of the assets which are the subject of adjustment and the limitations of predictions as to future events.
6. The primary judge’s reasons for not including the CGT were adequate. She correctly noted in her reasons that pursuant to Caruthers, the longer a property is likely to be retained, the less justification to take into account potential CGT liabilities because of the uncertainty of the liability and likelihood the holder of property will arrange his/her tax affairs so as to minimise tax. In declining to allow for the potential CGT, she noted the Husband’s unwillingness to agree to orders for transfer of properties to the Wife and his failure to seek orders for sale of those properties. Her Honour, conscious of the CGT issue made orders (in addition to the cash payment to the Wife) transferring the 4 properties to the Husband unencumbered so as to defer any issue of CGT in relation to settlement, subject to him being able to refinance the properties, which she considered he would be able to do having regard to his assets and borrowings and in the absence of the Husband calling evidence as to the impact on his assets in the face of this outcome, which aligned with the Wife’s application.
7. In short, the Husband failed to persuade the primary judge that the orders sought by him would result in the short to medium term crystalisation of CGT.
8. There was also a deficiency in the expert evidence the Husband relied upon in relation to quantum. The Husband asserted that the quantum of the CGT was not in dispute because the parties agreed on the calculation of quantum, based on particular assumptions, which assumptions were not made good at trial.

What have we learnt regarding Capital Gains Tax?

1. When determining the asset pool in a property settlement matter, the Court can take into account any capital gains tax implications that may arise in relation to the disposal of assets which may occur, such as an order to sell an investment property neither party wishes to retain;
2. Capital gains tax is likely to be taken into account and added to the property pool as a liability, where the court orders sale of an asset, or is satisfied that sale is inevitable or likely to occur in the near future.
3. The Court will examine the circumstances of the case, including the prospects of realisation of the assets, the circumstances of the acquisition and the intentions of the parties.
4. The greater the certainty and immediacy of a CGT liability, the greater the need to take it into account.
5. Just because the property was purchased as an investment is not sufficient for CGT to be included in the property pool. There needs to be sufficient evidence  of the likely disposal of the asset in the near future for profit.
6. If you are the person wanting the potential CGT to be included in the property pool, make sure you have clear evidence as to what the CGT liability is likely to be AND clear evidence supporting your intention to sell the asset, if not immediately, in the near future (i.e. more evidence than a self serving statement at Trial).
7. If you do not agree to orders for sale of an asset or for transfer of it to the other party, the Court is likely to infer from that evidence that sale of the asset is inevitable or likely to occur in the near future.

Contact us

Divorces often involve complicated capital gains tax issues and consequences where there are investment properties and shares.

Barton Family Lawyers has extensive experience dealing with complicated financial settlements which involve capital gains tax.

Barton Family Lawyers cannot however give financial, tax or accounting advice. This is the forte of an accountant or financial planner.

We strongly recommend that you obtain financial advice before entering into any financial settlement with a former spouse in relation to the division of your assets.

If you require assistance with respect to a division of your assets following a relationship breakdown, get in contact with us today to book a reduced rate initial consultation with one of our family law experts to have a confidential discussion about your individual circumstances.