Can I Be Liable for My Partner’s Tax Debts?
Quite often in Family Law property settlement, clients ask the question, “what forms the net asset pool?”
Generally, the simple answer is all of the parties’ assets minus their liabilities.
But this becomes more complicated when liabilities are in dispute, such as whether you should be held liable for your partner’s tax debts.
A common question that the Family Court faces when dealing with property settlement is who is responsible for the debt of the relationship.
In all but the most exceptional of circumstances, tax debt owed to the Australian Taxation Office (ATO) will constitute a liability of the relationship and therefore be included when calculating the net asset pool available for division.
Am I Responsible for My Spouse’s Debt?
Ordinarily, the Family Court will treat both parties to the relationship as having benefitted from the non-payment of tax, and accordingly, tax liability arising as a consequence of non-payment must be paid from the parties’ assets before the division of the relationship asset pool.
However, in Kowaliw and Kowaliw, the Court held that debts of a relationship are to be shared by the parties, except:
- Where one of the parties has embarked upon a course of conduct designed to reduce or minimise the effective value or worth of the assets; or
- Where one of the parties has acted recklessly, negligently, or wantonly with matrimonial assets, the overall effect of which has reduced or minimised the value.
Applying the Kowaliw Principles
More recently, the issue of tax avoidance in property settlement was raised in Commissioner of Taxation v Worsnop.
In particular, the Court discussed the issue of whether an ‘innocent’ spouse should bear the burden of a tax liability of which they were not aware despite enjoying the property and lifestyle benefits brought about by non-payment of tax.
The debt was incurred by the husband and his company, which allowed the Commissioner of Taxation to intervene in the Family Court proceedings.
The wife had no knowledge or reason to be aware of her husband’s tax avoidance.
The Court held the debts to the ATO were not taken into account in determining the available asset pool because the conduct was within the exceptions outlined in Kowaliw.
The Court gave significant weight to the wife’s knowledge (that is, lack of knowledge) of the tax avoidance and held that she was denied the ability to make a choice regarding the tax evasion, that is, likely demanding her husband pay tax.
Non-Inclusion of Tax Liability When Calculating Net Asset Pool
This decision supports the notion that a non-liable partner is not automatically required to suffer the burden of their partner’s debt, particularly when they are ‘innocent’ by way of non-complicity and ignorance.
When tax avoidance becomes an issue in family law proceedings, the Commissioner of Taxation’s interests must be balanced against those of the ‘innocent’ partner; they cannot be automatically considered when seeking alteration of property interests.
Commissioner of Taxation v Tomaras
A recent decision of the High Court has established that the Federal Circuit and Family Court of Australia (formerly known as the Federal Circuit Court) has the power to ‘substitute’ a tax liability, that is, order that the tax debts of one partner be reassigned to the other – even when one of the partners is bankrupt.
In Commissioner of Taxation v Tomaras, the High Court established that the Federal Circuit Court has the power to make orders that compel the ATO.
In Tomaras, one spouse who incurred a roughly ~$250,000 tax liability during the marriage, applied to the Court to have the tax liability reassigned to the other spouse, under a provision in the Family Law Act 1975 that permits the Court to make orders substituting one party for another about debts generally.
Tomaras’ argument was ultimately successful, and the High Court affirmed that the Federal Circuit Court has the power to reassign tax debts or ‘substitute’ debtors – even when, as in this case, one of the parties is bankrupt.
So, Am I Liable for My Spouse’s Debt?
Though the result of this case is a potential loss for the ATO, there was a net gain for taxpayers.
Spouses who have inherited or otherwise become liable for their partner’s tax debts can now be confident that the family courts will be able to assess their situation and, if necessary, reassign the debts to the partner responsible.
Alternatively, if one spouse is financially better off than the other, then they can be assigned the tax debts of a partnership as part of a property settlement where it is ‘just and equitable’ to do so.
This case also offers protection to spouses who may incur large income tax debts, possibly without even being aware of it.
An example of this is a homemaker who may incur a significant personal tax debt from passive distributions made from a family trust, but who may lack the ability to pay back such a debt.
The possibility of tax debts being reassigned to wealthier partners increases the chance that the full tax liability can be recovered.
It’s always important to be on top of your tax situation to avoid nasty surprises from the ATO.
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Related Blog – Tax Avoidance vs Tax Evasion: Key Differences & Consequences
