With property division between separated spouses, it has always been the position that the tax liability of one spouse is taken into consideration as part of the settlement as a liability of the marriage. However, as a result of the High Court decision of the Commissioner of Taxation v Tomaras [2018] HCA 62 handed down on the 13th of December 2018, the situation has advanced to where one spouse can actually substitute for the other spouse in terms of a liability owing to the Australian Taxation Office. Will this open the flood gates for one spouse to avoid paying tax at the expense of the other spouse?
Background
Mr and Mrs Tomaras married in July 1992. They separated 17 years later in July 2009.
During the marriage, the Commissioner of Taxation issued various assessments to Mrs Tomaras requiring her to pay, amongst other things, income tax, the Medicare levy, penalties and a general interest charge.
Mrs Tomaras failed to make any payments as assessed and furthermore did not lodge any objections to the assessments. The Commissioner obtained a default judgement for payment of the debt on 12 November 2009 which, at the time of the application, remained unpaid and was accruing a general interest charge.
On 5 November 2013, Mr Tomaras was declared bankrupt. About six weeks later, on 20 December 2013, Mrs Tomaras commenced proceedings in the Federal Circuit Court against the husband seeking an alteration of their property interests and an order that the husband be responsible for all income tax assessed on income received or deemed to have been received by the wife for the income tax year ending 30 June 2009 to the date of payment. At this stage the wife's liability to the ATO stood at $256,787.32. An order was also sought that the husband sign all documents to release the wife from and indemnify her against any present or contingent tax and bank liabilities.
The matter proceeded to trial and in February 2016 a Trial Judge granted the Commissioner of Taxation leave to intervene in the proceedings in relation to these orders sought.
The Trial Court referred the matter to the Full Court of the Family Court on the question of law as to whether the Trial Court (Federal Circuit Court of Australia) had power under Section 90AE(1) or (2) of the Family Court Act 1975 to order that the husband be substituted for the wife in relation to a taxation debt owed by the wife to the Commonwealth of Australia.
Legislation - Sections 90AE(1) and 90AE(2) of Family Law Act 1975 (as amended)
In proceedings under Section 79 (property division between two spouses) a debt owed by a party to a marriage is treated as property.
Section 90AE(1) allows, amongst other things, for an order binding the creditor to substitute one party for both parties in relation to a debt owed to the creditor and an order binding the creditor to substitute the other party or both parties to the marriage in relation to the debt owed to the creditor.
Section 90AE(2) allows, amongst other things, for an order that alters the rights, liabilities or property interests of a third party in relation to the marriage.
The Commissioner for Taxation argued that the Federal Circuit Court lacked the power to make such an order because the power of the Court did not extend to taxation debts owed by one or other of the parties to a marriage to the Commonwealth. Furthermore, the Commissioner argued that the Family Law Act was not binding on a Crown entity such as the ATO as usually a section in legislation would specifically state that it is binding on the Crown.
The Full Court of the Family Court held that the Court did have power to make the orders sought by the wife, but only on the basis that the Family Law Act confers power to direct the Commissioner to substitute one party for another in relation to a debt owed to the Commissioner.
The Commissioner appealed the decision of the Full Court of the Family Court to the High Court of Australia.
High Court Decision
The High Court held that Section 90AE of the Family Law Act did bind the Crown and concluded that the Trial Court did have the power under Sections 90AE(1) or (2) to order that the husband be substituted for the wife in relation to the tax debt owed by the wife to the Commonwealth of Australia.
The High Court, however, added a considerably important proviso to the question of law stated by the inferior Court. Specifically the High Court referred to Section 90AE(3) which provides that the Court may only make an order for substitution if (amongst other things):
- the making of the order is reasonably necessary, or reasonably appropriate and adapted, to effect a division of property between the parties to the marriage;
- if the order concerns a debt to a party to the marriage - it is not foreseeable at the time that the order is made that to make the order would result in the debt not being paid in full; and
- the court is satisfied that, in all the circumstances, it is just and equitable to make the order.
In other words, the Section states that the Court should not make an order for one party to the marriage to be substituted for the other in payment of the debt if it means that the tax would never be paid in full OR if it would not be just and equitable to do so. This proviso is pertinent to the facts of the case because the husband had been made bankrupt and therefore, on the face of it, the effect of substituting the husband would be that the tax debt would never be paid in full. As many of the judges pointed out, this fact alone should then dictate that the order is not made in this case.
In addition, one of the other arguments put forward by the Commissioner as to why the Court’s powers under s90AE should not extend to tax debts was that substitution of the party to a tax debt would impede the Commissioner’s powers under both the Income Tax Assessment Act 1936 and the Taxation Administration Act 1953 as to amendment of the assessment, recovery of any unpaid amount and imposition of general interest charge, as well as deny the party who becomes liable under the substitution the right to exercise any objection, review and appeal rights under the Taxation Administration Act 1953 in respect of the assessment.
While no conclusion was made by the Court as to whether the substitution would, in fact, impede the Commissioner’s powers and deny the taxpayer objection and appeal rights, the Court concluded that all of these factors would need to be taken into account in determining whether it is just and equitable to make the order. In doing so, the Court commented that the scope for s90AE to apply to substitute the person liable for a taxation debt would be limited.
Effect of Decision
With the Trial Court now having the power to make the order, the question will be: should the order be made, bearing in mind the husband’s bankrupt status? Therefore, it may be that Mrs Tomaras’ victory is short-lived, as the Trial Court may decide, because of the particular circumstances of this case, that to make the order would avoid the payment of the debt so refuse to make the order.
In situations however where bankruptcy of one party is not an issue, then there is the power now to make an order for the more financial spouse to take on a tax debt or penalty, provided the order does not result with debts not being paid and it is just and equitable to make the orders. As pointed out by the High Court, the uncertainty as to the effect of a substitution on the Commissioner’s powers of recovery, etc and the taxpayer’s rights of objection and appeal could, in itself, be enough for a court to determine that a substitution order in relation to a tax liability is not just and equitable.
In any event, it seems probable that the orders will only be considered in situations where one spouse is in a much better financial position than the other and could afford to discharge the debt and where there is unlikely to be any dispute in relation to the amount payable under the assessment.
It must also mean that if one party to the marriage is ordered to pay the debt of the other party, there will be an adjustment of property interests to reflect that the tax liability has been shifted from one spouse to the other. In other words, there should be an adjustment of property interest in favour of the spouse paying the debt.
Of particular note is the required wording for the orders. Often orders sought by parties are on the basis that one party be solely responsible for the debt, with the order requiring one party to either pay the debt or to indemnify the other party in respect of the debt. However an order on these terms will not be sufficient to substitute the other party under s90AE. Instead, the order has to be termed to direct the Commissioner of Taxation to substitute one party for the other.
Conclusion
In summary, therefore, it appears that parties are now able to consider substitution of tax liabilities as an option when drafting orders sought or negotiated settlements in property disputes, provided the wording of the order allows only substitution of one party to the marriage for the other.
However, given the reservations expressed by the High Court as to whether the impact of the substitution would adversely affect the rights and powers of both the Commissioner and the taxpayers in relation to, amongst other things, disputing the assessment and recovering the amount of the debt, it is likely that there will only seldom, if ever, be occasion for the court to actually exercise the power.
