Relationship Break Ups and Tax Tangles

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Relationship Break Ups and Tax Tangles

Relationship Break Ups and Tax Tangles

Normally when relationships come to an end the parties wind up embroiled in a battle for the assets and taxation is merely an afterthought.  In many situations tax should be at the forefront of the parties’ minds.

The Income Tax Act 2007 provides some special rules for the treatment of tax consequent upon the transfer of property made pursuant to a Relationship Agreement or pursuant to an order of the Court.  However, there are still significant tax issues that fall outside the particular rules in the Income Tax Act.

In the last ten years, mum and dad clients have become increasingly sophisticated and now we regularly examine complex structures involving companies and trusts that over time have become a tangled web of assets, debts, loans and losses that need careful untangling to avoid unintended tax consequences.

To make matters worse, tax considerations need to be coupled with an understanding of trust, company and property law.  Further, the order in which the untangling is undertaken can be critical and can require a comprehensive step plan that avoids triggering certain taxes.

Recently we were instructed on a matter where there were significant loans from the shareholders to a company. The separation agreement executed by the parties called for a Deed of Forgiveness of the Debt between the shareholders (creditor) and the company (debtor) and further provided the parties would cease to pursue the company for said debt.

From a relationship law perspective this may not ring alarm bells but from a tax perspective this would have been an expensive error.

Under present tax law, where a debtor’s liability is extinguished by either operation of law or forgiveness by the creditor, there is deemed to be an increase in the wealth of the debtor (with some exceptions of course). Debt remission would in this case produce taxable income to the debtor, but no reciprocal tax deduction to the creditor.

In this example, the debt remission amount was approximately $700,000 which equates to $200,000 in tax liability (simplistically calculated).

Where you are dealing with complicated settlements with multiple assets or complex loans it is prudent for the settlement agreement to be conditional on tax advice.

At Fortune Manning we can offer you tax advice in a legal context and provide a step plan (where required) detailing any tax issues, what documents are required and the order in which the various transactions should be implemented thereby avoiding any unintended tax consequences.

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