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Bankruptcy and Taxation Issues in Family Law

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Bankruptcy and Taxation issues should never be overlooked. This article discusses how these two financial areas might affect a Family Law matter, and the ramifications of failing to consider them.

Bankruptcy Issues

Bankruptcy is the legal declaration that a person is unable to pay their debts within a reasonable time. When a person is declared bankrupt, nearly all of their assets are placed with a bankruptcy trustee and then sold to pay the person’s debts.

In a family law matter, bankruptcy can occur at any of the following key events:

  • cohabitation;
  • marriage;
  • separation;
  • negotiating a property settlement;
  • documenting a settlement;
  • having orders made under the Family Law Act 1975 (Cth);
  • implementing those orders;
  • death; or
  • subsequent bankruptcy.

If faced with a bankruptcy in a family law matter, the consequences are significant and cannot be ignored.

The Australian Taxation Office may take legal action to recover outstanding tax and superannuation debts (depending on whether the debt is owed by an individual (or sole trader), partnership, trust, superannuation fund or company. This may include any of the following:

The interaction of family law and bankruptcy was simplified by amendments introduced to the Bankruptcy Act 1966 and the Family Law Act 1975 on 18 September 2005. In short, a property order can be made by the Family Law Courts even though property has vested in the bankruptcy trustee of a party which alters the interests of the trustee in the vested bankruptcy property.

The bankruptcy trustee may be joined as a party to proceedings in which a property order is sought and a party was a bankrupt, or before completion of proceedings a party becomes a bankrupt. If an application is made by the non-bankrupt spouse, the bankruptcy trustee may also be restrained from distributing dividends among creditors. Upon a bankruptcy trustee becoming a party, the bankrupt party is not entitled to make a submission to the Court in connection with any vested bankruptcy property without the Court’s leave.

Most importantly, the 4-step property settlement process still applies where a spouse is or becomes a bankrupt during the proceedings. This would include, but not be limited to, the potential transfer or sale of the former matrimonial home (which, contrary to popular belief, is not “a protected asset” under the Bankruptcy Act 1966).

Spousal maintenance may also be a “live issue,” such that the liability of a bankrupt party to maintain the other spouse may be satisfied, in whole or in part, by way of transfer of vested bankruptcy property in relation to the bankrupt party.

Taxation Issues

A Family Law matter will often give rise to immediate and/or long-term taxation issues where property division is involved – especially where one or both partners have an interest in a company or trust.

For instance, if capital gains tax (“CGT”) marriage breakdown roll-over relief applies to a post-GST asset while no immediate CGT liability will arise to any party, the transferee spouse may well be burdened with a potentially large CGT liability that is inherent in the asset if the asset’s market value at the time of roll-over exceeds the cost base of the asset at that time.

Alternatively, in other instances, an election available to one party in relation to a dwelling can significantly benefit the other party and this benefit must be considered in calculating entitlements and framing appropriate property orders.

The taxation issues that may arise to be considered in the course of negotiating a family law property division are often but one of a number of considerations that must be taken into account. Therefore, there may be other factors in a family law property division which will mean that a particular course of action is adopted, despite some tax advantage to one or both parties.

The Family Law team at Corney & Lind Lawyers is dedicated to seeing clients make fully informed decisions in their circumstances by providing them advice that is accurate and comprehensive. Contact us on (07) 3252 0011, or email enquiry@corneyandlind.com.au to see how our family lawyers can help you.