Case 096Client situations and behaviourHard
A divorcing couple splits Rs 16 crore: a house worth Rs 5 crore with a Rs 3 crore gain, equity funds worth Rs 6 crore with a Rs 2 crore gain, and Rs 5 crore of deposits. Show why a 50/50 split by market value is not 50/50 after tax, and fix it.
1The situation
Ketan and Priya Barve are divorcing and have agreed to split their Rs 16 crore equally. Their lawyers propose: Ketan keeps the house, worth Rs 5 crore and bought for Rs 2 crore, plus Rs 3 crore of deposits; Priya takes the equity funds, worth Rs 6 crore and bought for Rs 4 crore, plus Rs 2 crore of deposits. Each side gets Rs 8 crore at market value.
Use illustrative rates on eventual sale: 20% on the property gain and 12.5% on the equity fund gain, with deposits carrying no embedded gain. How a transfer between spouses under a divorce settlement is taxed, and what reliefs apply to a house sale, must be confirmed with a tax adviser.
2Your task
Who is really getting more, by how much, and what adjustment makes the split equal?
Quick check
Which spouse comes out ahead after the tax each asset carries?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Priya's half is worth about Rs 35 lakh more after tax, so the fix is to move about Rs 17.5 lakh of deposits from her to Ketan. The house carries Rs 60 lakh of embedded tax against Rs 25 lakh on the funds. After tax the estate is Rs 15.15 crore, so each side should get Rs 7.575 crore. If Ketan will live in the house for decades, the parties may agree to discount his tax for time.
Step 1Why is market value the wrong yardstick?
Because each asset comes with a tax bill attached that only appears when it is sold. Two cars with the same showroom price are not worth the same if one has an unpaid loan on it. The house has Rs 3 crore of gain carrying about Rs 60 lakh of illustrative tax; the funds have Rs 2 crore of gain carrying about Rs 25 lakh; deposits carry none. An asset's value to its new owner is its price less the embedded taxTax that will fall due on a gain already made but not yet realised, owed whenever the asset is eventually sold., and that is where the equal split stops being equal.
Step 2How big is the gap, and what is the fair split?
Put both sides on an after-tax basis. Ketan: Rs 5 crore less Rs 60 lakh plus Rs 3 crore is Rs 7.40 crore; Priya: Rs 6 crore less Rs 25 lakh plus Rs 2 crore is Rs 7.75 crore. The after-tax estate is Rs 15.15 crore, so each should receive Rs 7.575 crore. The difference between Ketan's share and that half, Rs 17.5 lakh, is what has to move.
| Asset | Market value, Rs crore | Gain, Rs crore | Illustrative rate | Embedded tax, Rs lakh | After tax, Rs crore |
|---|---|---|---|---|---|
| House | 5 | 3 | 20.0% | 60 | 4.400 |
| Equity funds | 6 | 2 | 12.5% | 25 | 5.750 |
| Deposits | 5 | 0 | 0.0% | 0 | 5.000 |
| Total | 16 | 5 | 85 | 15.150 |
Step 3How is the split fixed, and is the fix always right?
Move deposits, because they carry no tax of their own. Priya hands Ketan Rs 17.5 lakh of deposits; at market value he then holds Rs 8.175 crore and she Rs 7.825 crore, and after tax both hold Rs 7.575 crore. The fix assumes both assets are sold. If Ketan will live in the house for fifteen years, Rs 60 lakh due then is worth about Rs 22 lakh today at 7%, and a reinvestment relief might reduce it further. The parties must agree a method, sale date and discount rate, before the arithmetic.
Close with the adviser's role. You are not deciding the settlement; you are making sure both parties see the same numbers. A split agreed on market value can leave one person carrying most of the future tax without knowing it, and that is the conversation to have before signing, not after the first sale. Recommend each side confirm the tax treatment of the transfer and of a later sale with their own adviser.
Where candidates lose it
The usual miss is accepting Rs 8 crore each as equal because the market values match. The question hands you the gains precisely so you will convert each asset to its after-tax value.
The second is applying one tax rate to every asset. Property, equity funds and deposits are taxed differently, and the gap in this case comes from both the size of the gain and the rate on it.
What the interviewer asks next
- Priya would rather keep the house. Redo the split.
- The equity funds fall 20% in the six months before the settlement is signed. Who bears that?
- How would you split a family business share that cannot be valued precisely?
Company names and figures are illustrative.