Navigating the financial landscape of a separation can be as challenging as it is emotionally taxing. A separation involves more than just emotional and legal considerations; it has considerable financial ramifications too. In fact, when looking at the no-fault legislation and if you strip out the emotions, it is a financial transaction involving the division of assets.
When assets such as property, investments, or business interests are divided, the way these assets are valued and transferred can have tax consequences. For example, the sale or transfer of property might create tax. Many people have heard that there is an exemption to some taxes when there has been a relationship separation, however, it is important to understand how that exemption applies. For example, a property that would be taxed pursuant to the bright-line test that is sold to a third party upon separation will not benefit from such an exemption. Therefore, the parties will each need to account to Inland Revenue for the bright-line tax. If they do not factor this into the agreement, one party could be left with a higher tax burden due to their marginal rates (instead of the sale of the property and the associated tax debt being divided equally as a relationship debt). What is worse is when they do not realise the sale was subject to tax at all, and any settlement funds have been spent buying a new property. When Inland Revenue come knocking in a year or two, there will be a tax liability, associated penalties and interest, and no money to pay the bill.
If you are involved in family trusts or own a business, these entities also need to be carefully considered during a separation. Trust distributions and business valuations can have intricate tax implications that must be addressed to avoid future disputes or unexpected tax liabilities. There may be tax losses or imputation credits which need to be considered for continuity purposes. If there are losses that can be maintained, there will be a value for those losses which could be a substantial benefit for the person retaining that company or trust. There could be GST considerations that could lead to one party ending up with a very large GST liability, such as a GST registered trust which owns a property. If the Trust no longer has a taxable activity, then there will be a GST obligation to settle.
We were recently instructed to provide tax advice in relation to a transaction that was completed as part of a relationship property settlement. During separation, independent lawyers were instructed by the parties in a relationship property capacity, and an agreement was negotiated which involved the withdrawal of a foreign pension. Unfortunately, no tax advice was sought at the time and the lawyers did not seek tax advice, nor recommend their client’s sought tax advice. The withdrawal of the pension has resulted in a significant tax obligation for the party who owned the pension. The tax liability would have been a relationship obligation and should have been divided equally between the parties. However, the agreement has been drafted in such a way that one party has been left with a hefty tax burden that relates to the entire withdrawal, despite the fact the proceeds were divided between the parties. The party who incurred the significant tax liability was unaware of this until now when our advice was sought (some 10 plus years later), and now also has to pay interest as well as potential penalties. While we have provided advice and have been able to mitigate the penalties by providing a voluntary disclosure* this has understandably left a nasty taste in our client’s mouth.
Tax laws are complex, and mistakes or misunderstandings can lead to significant tax burdens and penalties. The financial implications of a separation can be far-reaching, and by understanding and addressing the tax impact early, you can make informed decisions. If you are going through a separation, please ensure your seek specialist tax advice to ensure any potential tax obligations are considered as part of the separation. We observe that many lawyers' engagement letters specify that they do not provide tax advice. While this is understandable as tax is a very specialist and technical subject, it does not mean there are no tax implications.
As tax lawyers who have expertise in relationship property law, we can provide you with invaluable guidance during a separation by seamlessly integrating tax strategies with property division options and proposals as they occur. This dual expertise ensures that both the financial and legal aspects of your separation are managed efficiently, and tax outcomes are effectively managed to ensure there are no nasty tax surprises as a result of the relationship property division. We recognise that most relationship property lawyers will not be tax experts, and as a result, we are regularly instructed by relationship property lawyers to provide tax advice on the proposed division of assets.
This article is intended for informational purposes only and should not replace specific tax or separation advice. For personalised advice on all tax and separation issues please contact us.
This article was accurate at the time of publishing.
* A voluntary disclosure is a legal process that allows a taxpayer to advise Inland Revenue of any errors made in previous tax positions, and comes with the benefit of significantly reduced (up to 100%) shortfall penalties. If a valid voluntary disclosure is provided to Inland Revenue prior to Inland Revenue providing notification of an audit, then any low-end shortfall penalties are reduced to zero as a result of a full and complete voluntary disclosure. For higher shortfall penalties, the reduction is 75%. Shortfall penalties can be imposed by the Commissioner of Inland Revenue on underpaid taxes. The amount of the shortfall penalty is based on the reason for the shortfall. We note that interest is charged from the original due date, and this is not reduced as part of the voluntary disclosure regime.
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