The breakdown of a marriage/civil partnership is very rarely easy, and the most common disputes generally arise over a couples’ assets, specifically the family home.
Tax is often overlooked on 1divorce, however the impact it can have can be significant and should be considered from the outset.
Timing and early advice is key.
Matrimonial assets will need to be divided and the timing of such events is key in assessing the tax implications. When assets are vast, such as joint ownership of more than one property and assets overseas, the process becomes more complicated.
Care should be taken and the relevant advisers included in discussions as early as possible. This ensures correct action is taken as to when and how assets should be divided between parties and the tax implications are clear for all and minimised where possible.
Take steps early
Married 2couples living together during a tax year can transfer assets between themselves on a nil gain nil loss basis, i.e. assets are deemed to be transferred at a value so that no CGT arises.
HMRC treat couples as living together unless, they are separated under:
- A court order
- By a deed of separation, or
- Where there is permanent separation.
Under current legislation, in these circumstances, any assets transferred following the tax year of separation but prior to 3decree absolute being granted will be deemed to be at market value regardless of whether any proceeds have exchanged hands as the individuals will be regarded as ‘connected persons’ until the divorce is finalised and decree absolute is pronounced.
Special rules apply where a capital loss arises during this period. These losses are known as ‘clogged losses’ and can only be offset against chargeable gains arising from transfers to the recipient spouse whilst they remain ‘connected’. It is therefore important to time transfers with this in mind.
The government have announced proposed changes to the timing of the CGT relief available to spouses who are separating.
If the changes are passed, from 6 April 2023, the transfer of assets between spouses who are in the process of separating will be given up to 3 years after ceasing to live together to make transfers to one another on a no gain, no loss basis, plus there will be unlimited time where the assets are subject to a formal divorce.
This will of course be welcome news to couples who are going through a separation and will remove the additional stress of needing to transfer assets within the tax year of separation to avoid unnecessary CGT, which, depending on the timing of the separation, i.e. if late in the tax year, could be a very short timeframe to deal with prior to the 5 April.
Should the individuals continue to hold property jointly following the divorce, they will no longer be regarded as connected parties, and so any transfer proceeds will be at the actual consideration received which may give rise to CGT liabilities. However, if the proposed changed come in, then assets transferred, which were subject to a formal divorce will no longer result in any CGT on a transfer between ex-spouses.
Extended Principal Private Residence (‘PPR’) Relief
Couples can only have one main residence between them. After separation, it would be common for one partner to move into alternate accommodation.
Gains arising from the disposal of an individual’s PPR are generally exempt from CGT. However, where a new property is bought or rented the PPR position could change. If the period between an individual moving out of the marital home and disposing of their interest is within 9 months (previously 18 months until April 2020), the full gain on disposal should be covered by PPR relief.
It is possible, in certain circumstances, to extend the 9 month period for the departing spouse but this is generally only when the property transfers to the occupying spouse as part of the divorce settlement and the departing spouse has not elected for another property to be their PPR.
The court can also make various orders creating a lifetime settlement or defer the gains depending on the specific circumstances of the couple and family.
PPR relief on transferring interest in jointly owned properties
A couple could own two properties in joint names and on separation each spouse subsequently wishes to live in one of the properties. They can have sole ownership of one property each by exchanging their interests on finalisation of the divorce. Each transferee must accept the original base cost and ownership period of the transferor and a joint claim made. Under the correct circumstances, it is possible to ensure that no CGT arises for either spouse.
In this situation, if each home were to be sold immediately after the transfer, then any gain would be relieved from CGT by PPR relief.
It is common for couples to have joint ownership in land such as a buy-to-let property portfolio. On divorce, they may wish to divide the properties between themselves to obtain sole ownership. This is likely to occur without any actual consideration exchanging hands.
If exchange is after the tax year of separation, as connected parties, the transfers will be deemed to be at market value which could give rise to significant CGT liabilities. Roll over relief provisions could apply and a claim could be made, if the conditions are met, allowing each party to defer the gain on the disposal of their respective shares of the properties.
The criteria are specific and complex and even if rollover relief is available, there may still be an element subject to CGT depending on the values involved.
Capital gains tax – New rules
From 6 April 2020, new rules came into place on disposals of UK residential properties. A UK Land Return needs to be completed and submitted to HMRC together with payment of any potential CGT liability within 30 days of the date of completion. A significant amount of information is required to complete the return which can often be time consuming. Penalties and interest will arise on delays in filing and payment of the tax due.
For divorcing couples, consideration needs to be given in being able to settle the CGT liability in a short space of time especially if no proceeds are received on disposal/transfer.
Income tax
In the UK, individuals are subject to income tax independently throughout marriage and on separation and divorce. If income generating assets, such as rental property or shares, are allocated on divorce, the receiving party will be subject to income tax on any income arising from these assets after receipt.
Maintenance payments are tax-free in the hands of the recipient and the payer does not qualify for any relief for such payments.
Stamp Duty Land Tax (SDLT)
SDLT is typically charged on the acquisition of a ‘chargeable interest’ in land. However certain interests are exempt, or non-chargeable and this can include certain transactions undertaken on the ending of a marriage or civil partnership, providing they take place as the result of:
- A court order or separation order; or
- An agreement between the partners in connection with the dissolution or annulment of their marriage or civil partnership.
Therefore, provided any property is transferred between the couple and not any third parties, as part of the divorce agreement, then it should be possible to avoid SDLT charges.
Where the divorce is drawn out, both parties are likely to retain an interest in the marital home until the divorce is finalised, the spouse moving out should not be subject to the 3% surcharge should they acquire another property but this is dependent on the specific facts of the situations and expert advice should be sought to ensure this is the case.
Inheritance Tax (IHT)
Throughout the period of separation and until decree absolute is received, transfers between spouses are exempt from IHT. Care should be taken where a UK domiciled spouse is transferring to a non-UK domiciled spouse. Different rules also apply on transfers following the decree absolute dependant on whether the transfers have been made as a result of a court order.
Non-UK assets
Where there are foreign assets being transferred, foreign currency movements could have an impact on the CGT position on disposal. In addition, local taxes would need to be considered.
Menzies LLP are part of the HLB International network and can obtain advice on such issues in most jurisdictions thereby giving clients all-inclusive advice.
Conclusion
Divorce is not something that many anticipate but when it does happen there are a number of tax implications which can impact on the couple’s final financial position. It is therefore beneficial to plan ahead and obtain the correct advice at the earliest opportunity to minimise liabilities and make the whole process less painful.
Notes
- 1Divorce also refers to civil partnerships being dissolved
- 2Couples refers to those in a marriage or civil partnership
- 3Decree absolute also refers to final dissolution order for civil partnerships
- 4Spouses also refers to civil partners