Tax considerations on separation and divorce
It has been well documented that recently we have seen a spike in the number of divorce cases, in part due to the additional strain placed on relationships during the pandemic.
Furthermore, in April 2022 there was a significant change in divorce law for England and Wales, which permits a ‘no fault’ divorce and generally makes the divorce process simpler. Under the new law, a simple statement is required that the marriage has irretrievably broken down and there will no longer be any need to point blame possibly leading to a further influx of divorce filings.
Following this change in law, thankfully, the UK tax system is also moving towards a more practical approach to divorce and separation.
Further to advice from the Office of Tax Simplification (the OTS), HMRC announced that couples who are separating will now have three years after the tax year in which they stop living together as a married couple to transfer assets between themselves without an immediate charge to Capital Gains Tax (CGT). Furthermore, this ‘no gain, no loss’ rule will apply with no time restriction if the assets are subject to a formal divorce settlement. The changes will affect disposals from 6 April 2023. This is welcome news and replaces the current position of ‘no gain, no loss’ treatment only available in relation to disposals in the remainder of the tax year in which the couple separate.
There are also some changes with regard to Private Residence Relief (PRR) for the disposal of main homes, which should make things easier for separating and divorcing couples.
We anticipate these changes will have a positive impact to allow separating couples to deal with their affairs and transfer assets without facing adverse tax consequences. We are thankful to see that the UK tax system is no longer financially burdening couples facing marital breakdown. With that in mind, although tax may not be at the top of the agenda when dealing with a divorce, it is important that those individuals seek the advice of a tax specialist as early as possible, in order to ensure assets are distributed in the most tax efficient way.
What are the key tax issues to consider?
Below we summarise some of the key issues to bear in mind on separation.
Capital Gains Tax (CGT)
If you are married or in a civil partnership, any assets transferred or gifted between you and your spouse/civil partner will be at a ‘no gain no loss’ basis, meaning that no taxable gains arise on the transfer of assets.
Should you separate, under current rules, you have until the following 5 April to make any transfers under the ‘no gain, no loss’ provisions.
From the following 6 April, while you are separated but are still legally married or in a civil partnership, you will be ‘connected persons’ for CGT purposes. This means that any transfers of assets between you will be deemed to take place at market value, even if no cash has exchanged hands. The result is that the person making the transfer could be left with a CGT liability, despite having not received any consideration to pay the tax.
The new tax changes from 6 April 2023, mean that you’ll have three years from the end of the tax year that you separate to make ‘no gain, no loss’ transfers. Or an unlimited time if the transfers are subject to a formal divorce settlement.
Family home and Private Residence Relief
It is important to consider the potential tax consequences when the family home is sold or transferred, particularly where the transferring spouse or civil partner has already left the marital home following separation.
For the purposes of Private Residence Relief (for CGT purposes), under current rules, the departing spouse is deemed to be resident in the house during the last nine months even if they have already bought or acquired another house as their main residence. Any sale or transfer of property after this nine month period could give rise to a CGT charge.
In certain cases, it is possible for this nine month period to be extended, but the property must be transferred to the occupying spouse as part of the divorce settlement, and the transferor must not have elected for any other property to be their main residence in the meantime.
From 6 April 2023, a spouse who retains an interest in the former matrimonial home will be given an option to claim PRR when it is sold. Furthermore, individuals who have transferred their interest in the former matrimonial home to their ex-spouse and who are entitled to receive a percentage of the proceeds when that home is eventually sold, will be able to apply the same tax treatment to those proceeds when received that applied when they transferred their original interest in the home to their ex-spouse. The PRR rules (old and new) are complex and should be considered in more detail before transfers occur.
Inheritance Tax (IHT)
Transfers between spouses are usually exempt from IHT. This remains the case during the period from separation to the decree absolute.
A transfer made after the divorce has been finalised will be a ‘Potentially Exempt Transfer’ (PET). This transfer can be liable to IHT if the donor dies within seven years from the date of transfer.
It is also important to bear in mind that divorce does not revoke an existing Will. As such, we recommend that this is reviewed and updated as appropriate.
Income tax
The transfer of assets under a divorce settlement is not subject to income tax.
However, if you have received income producing assets from your former spouse, such as income bonds or shares, you will be taxable on the interest and dividend income received since the date of transfer.
How can we help?
Timing is key, so it is important to contact us as early in the process as possible in order that we advise you accordingly.
