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Divorcing Couples – Beware of Capital Gains Tax

Author

Robert Wilson

As a Senior Tax Manager, Robert works across all levels of the business to aid and abet the delivery of tax advice across ETC’s broad and varied client base. He has a particular interest in the tax affairs of owner managed businesses and the personal affairs of the company shareholders, including profit extraction, exit planning and family wealth preservation.

Some may say that divorce is the psychological equivalent of a triple coronary bypass. Perhaps though if you asked Prince Andrew what his most stressful life experience has been, we’re sure that he now has many fond memories of his split from Sarah Ferguson.

Zsa Zsa Gabor and Liz Taylor certainly made process seem easy, but jokes aside, getting divorced can present a torrid time for many. The physical and emotional effort and administration required can be a drawn out, lengthy and costly process and should not be taken for granted.

Without wishing to make things worse, a divorce can often present many hidden tax issues for separating couples, particularly in respect of the capital gains tax (“CGT”) treatment of the eventual division of their assets. Hopefully, this article may make things a little clearer as to where an affected party may stand.

The default position

For tax identification purposes, spouses are classed as “connected persons”. Generally, the significance of this is that all transactions between connected persons take place at market value for CGT purposes. However, the only exception to this is transactions between spouses which take place at “no gain, no loss” i.e. neither a gain nor a loss arises to the donor as a result of the disposal.

Separating spouses

This “no gain no loss” treatment still applies provided the couple are living together and will continue to apply until the end of the tax year in which the couple separate. For example, if a couple separate part way through the tax year 2020/21, any transfers between them up until 5 April 2021 take place at no gain no loss. “No gain no loss” treatment does not apply after 5 April 2021 because the couple are separated.

However, the couple are legally married (or civil partners) until the date of divorce or dissolution. This means that after separation, the spouses are treated as connected persons for the purposes of tax.

As a result, any transfers which occur after the end of the tax year of separation, but before the actual divorce takes place, are deemed to take place at market value. This treatment applies up to the date the divorce is finalised with the decree absolute. In addition, a transfer made after divorce under a court order is treated in the same way. Thereafter, transactions take place as if between independent persons, thus subjecting the transaction to CGT.

The family home

Often, one of the most significant and contentious assets forming part of the divorce pleadings is the family home.

Principle private residence relief (“PPR”) means that anyone selling or transferring all or part of their main home does not need to pay CGT on the proceeds (subject of course to a myriad of factors!).

Non-separated spouses may only have one PPR at any one moment in time. For the purposes of PPR in the context of a divorce, spouses are treated as living together unless separated under a court order or formal deed of separation. Where the relationship has not broken down but the spouses live separately, they are still treated as living together for CGT purposes with one of the residences as the main home.

However, usually on separation, at least one of the parties will want to leave the shared home which, at this point, will no longer be their main home.

As such, for the purposes of claiming PPR, from 6 April 2020, the spouse who moves out of the family home will only have a nine-month window in which to sell/transfer their interest in the family before CGT applies to the proceeds of the sale (assuming they have been resident in the property throughout their period of ownership). This is a reduction to the 18-month period that applied to transaction before 6 April 2020 and is a recent change is to the final period exemption for PPR, which covers the final months of ownership of a residential property, regardless of whether the taxpayer is still living there.

Depending on the terms of the divorce, the separated couple may be required to agree to the sale of the family home. This may create two issues: –

  • The spouse remaining in the property is under no pressure to sell, whereas the departing spouse will wish to complete the sale within the 9-month period from separation. This may create an unfair advantage to the remaining spouse
  • If either spouse purchases another residential property in the intervening period whilst remaining an owner of the family home (even if they are not living there), they will be required to pay the 3% stamp duty surcharge applicable to second homes.

In respect of the family home, continuing to live together during the divorce process in order to avoid a CGT liability is unlikely to be pleasant for either party. Continuing to live together can also hugely complicate the divorce proceedings as, given the length of time it can take for a divorce to be finalised, the couple must explain to the court why they are continuing to live together despite their assertions that the marriage has broken down.

PPR may still be available under a specific statutory provision for the individual who has moved out if:

  1. The disposal is pursuant to an agreement in the divorce or a court order as part of a financial settlement; and
  2. The property continues to be the main residence of the spouse to whom the property is being transferred; and
  3. The spouse who moved out has not elected another home to be his/her main residence.

This relief is useful where the transfer takes place a while after one spouse moves out, but as can be seen from point 3 above, it is necessary for the leaving spouse to take steps to not elect for another property to be their primary residence. This would mean that any new property acquired would not qualify for PPR until such time as the previous property is transferred.

CGT Planning

Separating spouses must therefore take note of the timing of the separation and divorce when considering a transfer of assets as part of the divorce. Carefully thought through, the process of separating/getting a divorce can be planned so as to mitigate any CGT payable.

Ideally, the couple will reach agreement as to their entitlement to jointly and solely owned assets during the divorce proceedings, and preferably any transfers of assets between them will occur whilst the couple may still avail of the “no gain, no loss” treatment. However, this is not always practical.

Cash is a non-chargeable asset for CGT purposes and as such cash represents the most efficient way to equalise assets on divorce.

Non-cash assets can therefore pose an issue. Unfortunately, the wealthier you are, the more likely it is that you’ll own things such as collectibles, antiques, and property. Being illiquid assets, they’ll be difficult to dispose of, due to their expense, meaning it could take time to sell them.

For any jointly held assets which are to be sold, each of the couple has available to them and annual exempt amount for CGT purposes (currently £12,300 in the 2020/21 tax year). Assuming that this annual exempt amount has not been used elsewhere, the separating couple will be able to realise up to £24,600 tax free within the tax year of separation.

It is good tax practice to try to ensure that both spouses use their annual exempt amount each tax year. Therefore, if one spouse owns no chargeable assets and therefore does not make use of his or her CGT annual exempt amount, an agreement within the divorce proceedings could be to make a “no gain no loss” transfer followed by an immediate sale of the asset. This can help by ensuring that the annual exempt amount is utilised and brings down the overall tax bill with proceeds being divided in the agreed proportions.

In the tax year following the separation, qualifying business assets would be subject to CGT if transferred between separated spouses as we have discussed. Such assets may be eligible for a CGT relief known as ‘holdover’ or ‘gift’ relief. This works on the basis that the receiving spouse agrees with the transferring spouse that they will receive the assets at the original cost to the transferor.

However, the amount of gain qualifying for holdover or gift relief is restricted if there is consideration for the transfer. HMRC take the view that, in the absence of a Court order, the transfer takes place in exchange for consideration, being the surrender by the donee of the right to obtain alternative financial provision. This consideration is valued at such an amount as would reduce the gain eligible for holdover/gift relief to nil. So, in the absence of a Court order, no holdover/gift relief claim can be made.

On the other hand, if the transfer takes place under a Court order, the donee is not giving consideration for the transfer and hence a gift relief claim may be made.

How can we help?

We are a friendly, independent team of tax advisors and have experience representing clients and their advisors in negotiations and court proceedings arising out of a divorce.

As real people ourselves, we understand the emotional distraught that may be placed on a person due to ongoing divorce proceedings. Whilst we cannot fix a broken relationship, we can help fix any tax issues which may arise and provide clarity in respect of the tax position so as to ensure that your interests are protected in so far as possible and ensure that you do not fall into any traps.

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