Dealing with Debt Substitution and Creditors in the Family Court

15 February 2019

The recent High Court case of Commissioner of Taxation v Tomaras determined the Court has the power to shift a tax liability from one party to another.  Lawyers, accountants and financial advisors and their clients with substantial tax considerations should take heed.

The case determined if the conditions of section 90AE(3) are satisfied, a transfer of a tax debt from one party to the other may be on the cards.  While this case was limited to a tax debt, it could apply to any debt.

So what happened in the High Court case?

The case of Commission of Taxation v Tomaras considered whether the Family Court could substitute the husband to be solely liable to the ATO for a tax debt in the wife’s name.

The basic facts of this case are:

  1. During the relationship, the Commissioner of Taxation obtained default judgment against Mrs Tomaras for $127,669.36 consisting of outstanding income tax, Medicare levies, penalties and general interest charges.  The debt remains unpaid and given further general interest charges now stands at nearly $260,000.00.
  2. Subsequently, Mr Tomaras became bankrupt.
  3. In the next month Mrs Tomaras initiated proceedings in the Court seeking a family law property settlement. In particular she sought an order that the husband be responsible for her tax debt.   The Commissioner of Taxation also became a party to the proceedings.

The question put to the High Court

Section 90AE(1)-(2) of the Family Law Act grants the Court the power to order, during their family law case, that a debt – any debt – of one party, be paid by the other party.    Importantly, this is binding on creditors. The Question for the High Court, was whether the ATO was exempt as a Commonwealth revenue authority and had Crown Immunity from such general provisions of legislation? 

The unanimous decision of the High Court was that the Family Law Courts do have the power to bind the ATO.  

Question answered, the matter has now been referred back to the Federal Circuit Court for adjudication of the competing claims.  It is critical to note that even though the High Court has confirmed that the lower Court can make an order directing that one party to a marriage be substituted in the place of the other as a debtor to the ATO, it does not mean that the  Court will in fact follow that course of action. 

Section 90AE(3) of the Family Law Act sets out the conditions which must be satisfied for an order of substitution to be made.  In a nutshell the Court must be satisfied that:

  • The making of the order is reasonably necessary;
  • It is not foreseeable that the order would result in the debt not being paid in full;
  • The third party debtor has been accorded procedural fairness (in other words, they have been given the opportunity to be heard by the Court);
  • The Court is satisfied it is just and equitable to make the order; and
  • The order takes into account the taxation effect on the parties to the marriage, the third party and social security, the administrative costs and the capacity of the party of the marriage to repay the debt after the order is made.

Judges, Kiefel CJ and Keane J commented that:

‘Given that, so far as it appears from the record in the present case, the husband is a bankrupt and the wife is solvent, it is not possible to see how the condition in s 90AE(3)(b) could be satisfied in this case.  More generally, it is difficult to see how any case where there is a real prospect that the substitution of one spouse for another as a debtor of the revenue authority would create or enhance a risk of non-payment would not fall foul of Section 90AE(3)(b) of the Act.’

In other words, since the husband is bankrupt he won’t be able to pay the debt and there is no real chance that the order the wife wants will be made.

Other Considerations

Before seeking an order or coming to an agreement in a family law dispute that shifts the liability for a debt, the implications would need to be carefully considered.  These can include:

  • The impact on deductibility of the interest;
  • The impact if the underlying security is no longer with the party who holds the debt;
  • The estate planning implications.

In practice, this question does not regularly arise.  

A more common issue with debt in the Family Court is where one party is failing to meet their obligations which mean the asset put up as security is at risk.  In this case, the approach may not be to move the debt, but instead to stop the creditor from recovering the debt for a defined period.

Moores Case Study

Moores applied under this law to restrain a creditor from pursuing a debt until a family law case was finalised.

In a case Moores ran last year, our client sought to keep the family home which had a large mortgage on it.  It was in the other party’s sole name and he had not been paying the mortgage. The bank was threatening to foreclose. 

Moores successfully got an injunction to stop the bank proceeding, and ultimately got a very good result.  This enabled our client to keep the home and catch up the arrears of the mortgage payments.  Importantly, at all times our evidence was clear that the bank was not at risk of being out of pocket as there was plenty of equity in the home to cover their debt.

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