House of Representatives

Tax Laws Amendment (2006 Measures No. 4) Bill 2006

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 1 Marriage breakdown roll-over

Outline of chapter

1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to extend the marriage breakdown capital gains tax (CGT) roll-over to assets transferred to a spouse or former spouse because of:

·
a binding financial agreement under the Family Law Act 1975 (Family Law Act) or a corresponding written agreement that is binding because of a corresponding foreign law;
·
an arbitral award under the Family Law Act or a corresponding arbitral award under a corresponding state, territory or foreign law; or
·
a written agreement that is binding because of a state, territory or foreign law relating to de facto marriage breakdowns and that, because of such a law, cannot be overridden by an order of a court except to avoid injustice.

1.2 These amendments ensure that a capital gain or capital loss that would otherwise be made is deferred until the transferee spouse or former spouse disposes of the CGT asset.

1.3 These amendments ensure that the CGT main residence exemption interacts more appropriately with the marriage breakdown roll-over by taking into account the way in which both the transferor and transferee spouses use the dwelling.

1.4 These amendments also ensure that marriage breakdown settlements do not give rise to CGT liabilities.

Context of amendments

1.5 In 2000, the Australian Government enacted new binding financial agreement provisions in the Family Law Act to encourage separating couples to settle their own financial affairs rather than involve the courts.

1.6 The binding financial agreement provisions allow financial agreements to be entered into before marriage, during marriage, or after the breakdown of a marriage. Financial agreements provide a capacity for spouses (and intending spouses) to decide themselves how financial matters should be dealt with if their marriage breaks down, without having to bear the expense of having such matters determined by courts in accordance with Part VIII of the Family Law Act.

1.7 Arbitral award provisions, inserted in the Family Law Act in 1991, allow property or financial disputes following the breakdown of a marriage to be arbitrated. Arbitration can be ordered by a court or can be privately arranged.

1.8 All Australian States and Territories except Victoria have provisions for written agreements for de facto marriage breakdowns that are similar to binding financial agreements under the Family Law Act. Western Australia also has arbitral awards for de facto marriage breakdowns corresponding to those under the Family Law Act.

1.9 Other countries may also have similar written agreements and arbitral awards relating to the breakdown of legal and de facto marriages.

1.10 Currently, the CGT roll-over on marriage breakdown is available where an asset is transferred to a spouse or former spouse because of:

·
a court order or maintenance agreement under the Family Law Act or a corresponding foreign law; or
·
a court order under a state, territory or foreign law relating to de facto marriage breakdowns.

1.11 The present lack of a similar CGT roll-over for binding financial agreements and arbitral awards inhibits their use. These amendments further encourage separating couples to settle their own affairs without involving the courts by removing potential CGT impediments.

1.12 The policy rationale for the CGT marriage breakdown roll-over (including as extended by these amendments) is that the transfer of assets occurs compulsorily or in the shadow of compulsion.

Summary of new law

1.13 Subdivision 126-A of the ITAA 1997 currently provides a CGT roll-over if a relevant CGT event happens because of a maintenance agreement made before 27 December 2000 or because of a court order.

1.14 The effect of the CGT roll-over is that:

·
a capital gain or capital loss that would otherwise be made by the individual, company or trustee when the CGT asset is disposed of or created in another individual (the transferee spouse) is disregarded - the accrued capital gain or capital loss is deferred until the transferee spouse disposes of the CGT asset or creates the CGT asset in another entity; and
·
for a disposal case, where the individual, company or trustee acquired an ownership interest in the dwelling before 20 September 1985, the transferee spouse is taken to have acquired it before that day.

1.15 These amendments extend the existing CGT roll-over to a relevant CGT event that happens because of:

·
a binding financial agreement under the Family Law Act or a corresponding written agreement that is binding because of a corresponding foreign law;
·
an arbitral award under the Family Law Act or a corresponding arbitral award under a corresponding state, territory or foreign law; or
·
a written agreement that is binding because of a state, territory or foreign law relating to de facto marriage breakdowns and that, because of such a law, cannot be overridden by an order of a court except to avoid injustice.

1.16 These amendments also ensure that the CGT main residence exemption interacts more appropriately with the marriage breakdown roll-over by taking into account the way in which both the transferor and transferee spouses use the dwelling during their combined period of ownership when determining the transferee spouse's eligibility for the main residence exemption.

1.17 In addition, these amendments ensure that marriage breakdown settlements do not give rise to CGT liabilities.

Comparison of key features of new law and current law

New law Current law
An automatic CGT roll-over applies to a relevant CGT event because of:

·
a court order under the Family Law Act or a corresponding foreign law;
·
a maintenance agreement approved by a court under section 87 of that Act or a corresponding agreement approved by a court under a corresponding foreign law;
·
a court order under a state, territory or foreign law relating to de facto marriage breakdowns;
·
a financial agreement made under the Family Law Act that is binding because of section 90G or a corresponding written agreement that is binding because of a corresponding foreign law;
·
an award made in an arbitration referred to in section 13H of that Act or a corresponding award made in an arbitration under a corresponding state, territory or foreign law; or
·
a written agreement that is binding because of a state, territory or foreign law relating to de facto marriage breakdowns and that, because of such a law, cannot be overridden by an order of a court except to avoid injustice.

An automatic CGT roll-over applies to a relevant CGT event because of:

·
a court order under the Family Law Act or a corresponding foreign law;
·
a maintenance agreement approved by a court under section 87 of that Act or a corresponding agreement approved by a court under a corresponding foreign law; or
·
a court order under a state, territory or foreign law relating to de facto marriage breakdowns.

It does not extend to financial agreements, corresponding agreements or arbitral awards.

Where the transferor spouse acquired an ownership interest in a dwelling after 19 September 1985 and the marriage breakdown roll-over is available to the transferor spouse, the CGT main residence exemption rules take into account the way in which both the transferor and transferee spouses used the dwelling when determining the transferee spouse's eligibility for the main residence exemption. Where the transferor spouse acquired an ownership interest in a dwelling after 19 September 1985 and the marriage breakdown roll-over is available to the transferor spouse, the CGT main residence exemption rules take into account the way in which only the transferee spouse used the dwelling when determining the transferee spouse's eligibility for the main residence exemption.
Marriage breakdown settlements do not give rise to CGT liabilities. Marriage breakdown settlements may technically give rise to CGT liabilities, as they result in the ending of an intangible asset.

Detailed explanation of new law

Marriage breakdown roll-over

1.18 Subdivision 126-A of the ITAA 1997 provides a CGT roll-over if a relevant CGT event happens involving an individual, a company or a trustee and the individual's spouse or former spouse because of:

·
a court order under the Family Law Act or a corresponding foreign law;
·
a maintenance agreement approved by a court under section 87 of that Act or a corresponding agreement approved by a court under a corresponding foreign law; or
·
a court order under a state, territory or foreign law relating to de facto marriage breakdowns.

1.19 These amendments provide a CGT roll-over if a relevant CGT event happens involving an individual, a company or a trustee and the individual's spouse or former spouse because of something done under:

·
a binding financial agreement under the Family Law Act or a corresponding written agreement that is binding because of a corresponding foreign law;
·
an arbitral award under the Family Law Act or a corresponding arbitral award under a corresponding state territory or foreign law; or
·
a written agreement that is binding because of a state, territory or foreign law relating to a de facto marriage breakdown and that, because of such a law, cannot be overridden by an order of a court except to avoid injustice.

[Schedule 1, items 3 and 7, paragraphs 126-5(1)(d) to (f) and 126-15(1)(d) to (1)(f)]

1.20 Under the income tax law, spouse includes a man and a woman who, although not legally married, live together on a genuine domestic basis as husband and wife. The CGT roll-over can only apply where the definition of spouse is met.

1.21 This amendment ensures that certain transfers of assets between spouses on the breakdown of a relationship does not give rise to a capital gain or capital loss. The roll-over is provided in these circumstances because the transfer of assets occurs compulsorily or in the shadow of compulsion.

Binding financial agreements and similar agreements

1.22 The Family Law Act allows financial agreements to be entered into before marriage (section 90B), during marriage (section 90C), or after the breakdown of a marriage (section 90D). Financial agreements provide a capacity for spouses (and intending spouses) to decide themselves how financial matters should be dealt with if their marriage breaks down, without having to bear the expense of having such matters determined by courts in accordance with Part VIII of the Family Law Act. Section 90G specifies the circumstances in which a financial agreement is binding on the parties to the agreement.

1.23 Property or financial disputes following the breakdown of a marriage can also be determined by arbitration (under section 13H of the Family Law Act).

1.24 The extended CGT roll-over is provided to transactions done under:

·
a financial agreement that is binding on the parties to the agreement because of section 90G of the Family Law Act [Schedule 1, items 3 and 7, subparagraphs 126-5(1)(d)(i) and 126-15(1)(d)(i)] ; and
·
an award made in an arbitration of a property or financial dispute under the Family Law Act [Schedule 1, items 3 and 7, subparagraphs 126-5(1)(e)(i) and 126-15(1)(e)(i)] .

1.25 All Australian States and Territories except Victoria have laws for written agreements relating to de facto marriage breakdowns that are binding and cannot be overridden by an order of a court except to avoid injustice. Currently these are:

·
a domestic relationship agreement or a termination agreement that complies with subsection 47(1) of the New South Wales Property (Relationships) Act 1984 ;
·
a recognised agreement within the meaning of the Queensland Property Law Act 1974 ;
·
a cohabitation agreement that is a certificated agreement within the meaning of the South Australian De Facto Relationships Act 1986 ;
·
a personal relationship agreement or separation agreement that complies with subsection 62(1) of the Tasmanian Relationships Act 2003 ;
·
a financial agreement that complies with subsection 205ZS(1) of the Western Australian Family Court Act 1997 ;
·
a domestic relationship agreement or a termination agreement that complies with subsection 33(1) of the Australian Capital Territory's Domestic Relationships Act 1994 ; and
·
a cohabitation agreement or a separation agreement that complies with subsection 45(2) of the Northern Territory's De Facto Relationships Act .

1.26 Western Australia also provides arbitral awards for de facto marriage breakdowns similar to those under the Commonwealth's Family Law Act. The extended CGT roll-over is provided to transactions done under such an award.

1.27 Other countries (including part of a foreign country, such as a state or province) may also have similar written agreements and arbitral awards relating to the breakdown of legal marriages and de facto relationships. The extended CGT roll-over is provided to transactions done under such agreements or awards. [Schedule 1, items 3 and 7, subparagraphs 126-5(1)(d)(ii) and (e)(ii), 126-15(1)(d)(ii) and 126-15(1)(e)(ii)]

Conditions for the roll-over

1.28 The CGT roll-over will only apply to a financial agreement under the Family Law Act, a corresponding written agreement because of a corresponding foreign law or a written agreement relating to de facto marriage breakdowns if certain conditions are met. [Schedule 1, items 4 and 8, subsections 126-5(3A) and 126-15(5)]

1.29 These conditions are:

·
at the time of the trigger event, the spouses involved are separated and there is no reasonable likelihood of cohabitation being resumed; and
·
the trigger event happened because of reasons directly connected with the marriage or de facto marriage breakdown.

[Schedule 1, item 9, subsection 126-25(1)]

1.30 The question of whether spouses have separated is to be determined in the same way as it is for the purposes of section 48 of the Family Law Act, as affected by sections 49 and 50 of that Act. [Schedule 1, item 9, subsection 126-25(2)]

1.31 This does not introduce a requirement that the parties are separated for 12 months.

1.32 There may be situations where transfers would not be because of reasons directly connected with the breakdown of the marriage. This may be the case if, for example:

·
the spouses had an agreement before the breakdown of the marriage or de facto marriage that the particular property was to be transferred between them for other reasons not directly related to the marriage breakdown; or
·
the agreement provided for the transfer of non-specific property, the transfer does not occur for a considerable time (say, more than 12 months) after the agreement and factors are present that suggest the transfer was not directly connected to the marriage breakdown.

Consequences

1.33 The consequences of the marriage breakdown CGT roll-over are set out in existing subsections 126-5(5) to 126-5(7) for the disposal case and subsection 126-5(8) for the creation case. Where the relevant CGT event involves a company or trustee, additional consequences occur as set out in existing subsections 126-15(2) to 126-15(4). Broadly, the consequences of the marriage breakdown CGT roll-over are:

·
a capital gain or capital loss that would otherwise be made by the individual, company or a trustee when the CGT asset is disposed of or created in another individual (transferee spouse) is disregarded - the accrued capital gain or capital loss is deferred until the transferee spouse disposes of the CGT asset or creates the CGT asset in another entity; and
·
for a disposal case, where the individual, company or trustee acquired a CGT asset before 20 September 1985, the transferee spouse is taken to have acquired the asset before that day - that is, the pre-CGT status of the asset is preserved.

Main residence exemption

1.34 Where the transferor spouse acquired an ownership interest in a dwelling after 19 September 1985 and the marriage breakdown roll-over is available to the transferor spouse, the CGT main residence exemption rules take into account the way in which both the transferor and transferee spouses used the dwelling, during their combined period of ownership, when determining the transferee spouse's eligibility for the main residence exemption. [Schedule 1, items 2, 5 and 6, subsection 118-178(2), note 2 to subsection 126-5(5)]

Example 1.1 Caroline (the transferor spouse) is the 100 per cent owner of a dwelling that she used only as a rental property for five years before transferring it to David (the transferee spouse). The transfer happens after the day of Royal Assent of this Bill and CGT roll-over applies. David uses the dwelling only as a main residence for five years before selling it.David will be eligible for a 50 per cent main residence exemption having regard to how both Caroline and David used the dwelling. Example 1.2 Peter (the transferor spouse) is the 100 per cent owner of a dwelling that he used as a rental property for three years then as a main residence for three years before transferring it to Susan (the transferee spouse). The transfer happens after the day of Royal Assent of this Bill and CGT roll-over applies. Susan uses the dwelling only as a rental property for six years before disposing of it.Susan will be eligible for a 25 per cent main residence exemption having regard to how both Peter and Susan used the dwelling.

1.35 Where a dwelling that is used as a main residence from the time of purchase is later used to produce income and is transferred to the transferee spouse, the special rule for when a dwelling is first used to produce income applies (existing section 118-192 of the ITAA 1997) if that first income-producing use was after 20 August 1996. That is, the transferee spouse is taken to have acquired the ownership interest in the dwelling at the time it is first used to produce income for its market value at that time.

Example 1.3 George and Natalie are each 50 per cent owners of a dwelling that they used only as a rental property for two years before George transferred his 50 per cent interest to Natalie. The transfer happens after the day of Royal Assent of these amendments and CGT roll-over applies. Natalie uses the dwelling as her main residence for four years from the date of transfer until she sells it.Natalie is entitled to a 66? per cent main residence exemption on the 50 per cent that she originally owned. She is entitled to a 66? per cent main residence exemption on the 50 per cent interest that was owned by George and transferred to her, having regard to how both Natalie and George used the dwelling. Example 1.4 Harry (the transferor spouse) is the 100 per cent owner of a dwelling that he acquired for $100,000 in 1999 and used as a main residence for three years. In 2002, he decided to use the dwelling to produce income; it was valued at $150,000 at this time. He later transferred the dwelling to Anita (the transferee spouse). The transfer happens after the day of Royal Assent of this Bill and CGT roll-over applies.Anita is taken to have acquired the ownership interest in the dwelling in 2002 for the market value at that time of $150,000.

1.36 The amendments do not prevent the operation of existing section 103-25 of the ITAA 1997 in relation to choices that may be available to the transferor spouse to treat a dwelling as their main residence under Subdivision 118-B during their ownership period - for example, under existing sections 118-145, 118-150 and 118-160.

1.37 Such choices are not required to be made by the transferor spouse where roll-over applies because the capital gain or capital loss is disregarded. However, there is nothing to prevent the transferor spouse making a choice - for example, as part of the negotiations with the transferee spouse and transferee spouse's advisers about the transfer of an ownership interest in a dwelling.

1.38 If there was a period when the transferor and transferee spouse had different main residences before they separated, they need to make a choice under section 118-170 to:

·
treat one of the dwellings as the main residence of both of them for the period; or
·
nominate the different dwellings as their main residences.

1.39 Relevant choices generally need to be made by the day the person lodges their income tax return for the income year in which the CGT event happens and are generally evidenced by the way the person prepares their return.

1.40 However, for the practical reasons of negotiating a property settlement, any choices the transferor spouse decides to make would generally be expected to be made before they transfer their ownership interest to the transferee spouse.

1.41 A signed statement could be provided by the transferor spouse to the transferee spouse in these circumstances as evidence of the making of a choice.

1.42 The Commissioner of Taxation has authority in appropriate cases to allow further time for a choice to be made after the time it is required to be made under the law.

1.43 Once a choice is made, it is binding and cannot be changed.

Example 1.5 At the time of negotiating their property settlement on the breakdown of their marriage in 2007, Calvin and Denise discuss with their advisers how to divide their joint assets.In 1998, when she was single, Denise bought a townhouse which she lived in for three years. In 2001, Denise and Calvin rented a flat and started living together as husband and wife. At that time, Denise began renting out her townhouse. In 2003, after living together for two years in the flat, Denise and Calvin bought a house and moved in. Denise continued to rent out the townhouse.In 2007, their relationship broke down. Denise and Calvin decided that Calvin would transfer his 50 per cent interest in the house to Denise (where she and their daughter would continue to live) and she would transfer the townhouse to Calvin (for him to live in) under a binding financial agreement.Because the townhouse had been Denise's main residence, she could choose under section 118-145 to continue to treat it as such for up to six years of any period of absence.In negotiating their binding financial agreement, Denise provided Calvin with a signed statement which indicated she had chosen to treat the townhouse as her main residence for the two years between the time she moved out and the time they bought the house together.Calvin is taken to have acquired the townhouse for its market value in 2001 (under section 118-192) and will qualify for partial main residence exemption when he sells it. (The period from 1998 to 2001 is ignored from their combined period of ownership.)The effect of Denise's choice is that the townhouse is exempt from CGT for the period between 2001 (when she moved out) and 2003 (when she and Calvin bought the house together). So when Calvin sells it, he will get exemption for the period from 2001 to 2003 and for the period he lived in it after the marriage broke down.If Denise had not made the choice under section 118-145, Calvin would not get the exemption for the period from 2001 to 2003.

Marriage breakdown settlements

1.44 These amendments ensure a capital gain or capital loss that is made on a right ending (ie, on CGT event C2 happening to a right) is disregarded if certain conditions are met. This means that marriage breakdown settlements do not give rise to CGT liabilities.

1.45 The conditions are that:

·
the capital gain or capital loss is made in relation to a right that directly relates to the breakdown of a marriage or de facto marriage;
·
at the time of the trigger event, the spouses involved are separated and there is no reasonable likelihood of cohabitation being resumed; and
·
the trigger event happened because of reasons directly connected with the marriage or de facto marriage breakdown.

[Schedule 1, item 1, subsection 118-75(1)]

1.46 There may be situations where transfers would not be because of reasons directly connected with the breakdown of the marriage. The question whether spouses have separated is to be determined in the same way as it is in the Family Law Act. [Schedule 1, item 1, subsection 118-75(2)]

Application provisions

1.47 The amendments that relate to the marriage breakdown roll-over and the main residence exemption apply to CGT events that are trigger events for the purposes of Subdivision 126-A of the ITAA 1997 and that happen after the date of Royal Assent of this Bill.

1.48 The amendment that relates to marriage breakdown settlements applies to CGT events that happen after the date of Royal Assent of this Bill. [Schedule 1, item 10]


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