[Question] Divorce settlement and tax

[Beancounter]

I need advice on a matter. The spouses are getting a divorce. They own equal shares in a company. The company sold the property it owned and made a Capital Gain of R5m. The property was not the primary residence. The wife is entitled to the profit in terms of the divorce settlement agreement. The company will pay CGT on the profit and then the remaining profit has to go to the wife. How does the remaining profit get taken out of the company in a way that legally minimizes any tax burden to any / all of the parties i.e. the company, husband and wife?

I am of the view that, if the remaining profit is distributed to a director in the current tax year, then it will take the form of director's remuneration and will be considered income in terms of the definition of gross income of the Act. The director will then be taxed on it. If the profit is distributed after the end of the current tax year, then it will take the form of a dividend from retained earnings and the director will have to pay 20% dividends tax. Dividends tax will be less than Income Tax at her marginal tax rate in terms of the tax tables. The confusing issue here is that the money constitutes part of a divorce settlement and a person should not be taxed on money received in terms of a divorce settlement. The fact that the money is profits stuck in a company though, is presenting a hurdle. And the settlement agreement does not cover any tax related matters.

Should the profits rather be distributed (but not paid) to the husband and an IRP5 issued to him or distributed to him as dividends and then he pays tax on it seeing that the wife is entitled to the full profit? Then the company pays the profits out to the wife in terms of the settlement agreement and supported by a resolution by the directors that it is done this way. Or is it rather fairer to split the profits by issuing IRP5's / dividends to both and they both get taxed equally? But then the wife gets penalized on her settlement amount.

The husband wants to retain all of the shares in the company after this and use the company for other business in future. I was even thinking of leaving the profit in the company then and transferring the funds from the company to him on a loan account so he can pay her her settlement. Then that leaves him with a loan that he has to pay back to the company, or he can take a dividend later and deal with the tax.

[Dave A]

The divorce agreement cannot be ultra vires.

Given that the property is within a company, I would be inclined to argue the the distributable profits of the sale are diminished by tax whether they are drawn via the ex-husband or ex-wife, and that the ex-wife is only due the amount nett of taxes.

[Beancounter]

Thank you Dave

The divorce agreement cannot be ultra vires.

Given that the property is within a company, I would be inclined to argue the the distributable profits of the sale are diminished by tax whether they are drawn via the ex-husband or ex-wife, and that the ex-wife is only due the amount nett of taxes.

I sent the question to the SAIT as well and this was their response:

Dear Member,

You have correctly identified the options. Either way, the gain is made in the company and must be taxed there, applying the company rate to 80% of the gain. This gives an effective tax of 22.4% of the gain. It would be unwise for the company to pay the remaining 77.6% to the wife as remuneration, as she would be fully taxable on the amount. The only other way is for the company to declare a dividend, which would be subject to the 20% dividends tax. But a company can’t pay a dividend to one shareholder and not to another shareholder of the same class of shares. In addition, does the divorce agreement state that the wife is entitled to the gross grain or to the after tax portion?

1. If she is entitled to the gross gain, the company should declare the dividend to the respective shareholders, after which the husband must pay to the wife the amount needed to top up her amount to what she is entitled to. This will not be a donation as it will be made in terms of an obligation in the divorce order.

2. If she is entitled to the net gain after CGT, the same procedure as above save that the amount payable by the husband will be less.

3. If she is entitled to the net amount after CHT and dividends tax, the same procedure as above save that the amount payable by the husband will be even less.



There is another option but it’s more complicated. You split the share capital into two classes, ords and A ords. This of course requires a change to the MOI and registration with CIPC. Say the husband’s share comprises the ords and the wife’s the A ords. The company then pays a dividend to the A ords shareholder, being the wife, in the amount to which she is entitled in terms of the divorce order. As you will appreciate, this is more time consuming and expensive than the options discussed above.

[Dave A]

In addition, does the divorce agreement state that the wife is entitled to the gross grain or to the after tax portion?

My experience is that divorce orders are often not nearly specific enough to that level of detail...

Out of idle interest, was this one that specific?

[Beancounter]

My experience is that divorce orders are often not nearly specific enough to that level of detail...

Out of idle interest, was this one that specific?

The settlement agreement hasn't been signed yet, but I got a copy of the document for perusal. It actually states that the wife should get a specified lump sum after all taxes and if there is a shortfall, the husband must make up the difference. Very long document and I must say, very attentive attorneys for a change.

Nonetheless, it was my mandate to ensure that the optimum tax balance was reached legally and that no party should be adversely affected by it. Success!