When is it worth protecting the bank? When it’s the bank of Mum and Dad.

18 October 2018
Rose Lockie, Partner, Melbourne

It is commonplace for parents to provide their children with money to fund weddings, house deposits, cars, business ventures and other purchases. However, when adult children separate from their spouses or de facto partners, the characterisation of that money as either a gift or a loan can be called into question, and money from the bank of Mum and Dad can (despite any intention to the contrary) end up forming part of the divisible asset pool.

So when is a loan a loan? That question was considered in the recent tax decision of Rowntree v FCT [2018] FCA 182 and there are some important takeaways from a family law perspective.

The key facts 

Mr Bruce Rowntree (“Mr Rowntree”) engaged in numerous transactions with companies he controlled. As a result of those transactions, Mr Rowntree received over $4 million from those companies over four financial years. The Commissioner of Taxation assessed those funds as income. Mr Rowntree applied to the Administrative Appeals Tribunal (“the Tribunal”) to review that assessment on the basis that those funds were loans to him from the companies, and not income.

In arguing the funds were loans and not income, Mr Rowntree pointed to various documents to prove the existence of the alleged loans, some of which were dated after the relevant transactions. He also argued that a loan agreement existed by inference. However, Mr Rowntree lacked evidence of a corroborating and contemporaneous contract. The Tribunal considered that even in circumstances when repayments had been made, such repayments alone were not sufficient evidence to prove that there was an obligation to repay.

What constitutes a loan agreement?

The Tribunal referred to the comments of Edmonds J in Federal Commissioner of Taxation v Rawson Finances Pty Ltd [2012] that:

The essence of a loan of money from A to B is a corresponding contemporaneous obligation on the part of B to repay the money transferred from A to B… Absent that obligation, the transfer of the money from A to B is something else – a gift, a payment by direction, a payment or repayment of an anterior obligation –  but it is not a loan.

The obligation of repayment is not proved by subsequent payment of the same amount, let alone a different amount, from B to A; that may be explicable by reference to another obligation or circumstance having nothing to do with the original payment from A to B. Rather, the obligation of repayment is proved by the terms of the contract under which the money was transferred from A to B.

What does this mean for the bank of Mum and Dad? 

Unfortunately, a hastily drawn “agreement” on a piece of paper after money has changed hands will not be sufficient to prove that a loan existed at the time of the transaction. If parents want to provide their child with a monetary sum, but do not want to see those funds later included in the divisible asset pool between their child and their former spouse/de facto partner, they must have a properly documented loan agreement in existence either before, or contemporaneous with the provision of the funds, that contains a genuine repayment obligation.

Even in circumstances where the loan has been appropriately documented (and may also have been secured by way of mortgage on title and/or recorded in the minutes and in the financial statements of the mum and dad operated entity), it may still treated as a gift by the Family Court if subsequently there are no repayments, or the loan was not considered to be on commercial terms.

As an added layer of protection, the beneficiary of a loan can also enter into a Financial Agreement with their spouse/soon to be spouse/ de facto partner, and the relevant parent/s or guardian can also be party(ies) to that Agreement, to effectively quarantine the loaned money in the event of a separation. A properly drawn and entered into Financial Agreement will be binding and enforceable, and enables parties to contract out of the Family Law Act 1975 (Cth).

For specific legal advice in relation to this matter, please contact the Family Law team at Gadens.

Authored by:
Jodylee Bartal, Partner
Elese Cartledge, Associate

This update does not constitute legal advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek legal or other professional advice before acting or relying on any of the content.

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