Taxing times – relationship breakdown and divorce

Taxing times – relationship breakdown and divorce

When a marriage or civil partnership breaks down, the thing furthest from the couple’s minds is going to be tackling some complex – but crucial – tax matters. Here we look at what couples should consider in the midst of this highly emotional and stressful event.

Income Tax and Inheritance Tax (IHT)
There is no immediate tax charge upon transfer of assets under a divorce settlement, for either IHT or Income tax purposes right up to point of final annulment. After that, normal tax rules will apply. Where a Mesher order has been granted, then IHT needs to be looked at carefully and a long term plan put into place.

Capital Gains Tax (CGT)
The key issue to consider is Capital Gains Tax, or CGT. The parties involved will need to loot at any transfers between spouse/civil partners on the breakdown of the relationship. Timing here is key, especially when minimising any potential CGT liabilities (although be aware – speeding up the transfer of assets may not necessarily benefit both parties).

Date and year of separation
The date of permanent separation is significant for CGT purposes – it is not simply the date when one partner moves out of the matrimonial home. According to HMRC, spouses/civil partners are treated as living together (and subject to the ‘no gain, no loss’ transfer rules), unless they are separated in one of the following circumstances:-

  • under a Court order;
  • by a formal Deed of Separation executed under seal (in Scotland, a deed should be witnessed); or
  • in such circumstances that the separation is likely to be permanent.

Whilst the latter is debatable, the date of separation is a matter of fact; it is not possible to state one date in formal documents, such as a divorce petition or Form E, and to use an alternative date for CGT purposes.

A gift of disposal of assets between spouses/civil partners is usually exempt from CGT, under the ‘no gain, no loss’ rules. If spouses/civil partners are living together at some time in the tax year of permanent separation, any transfers between them will be exempt from CGT. There is also no requirement for them to live together at the time of the transfer.

Parties will often want to speed up the transfer of assets to take advantage of the CGT exemption. A May separation, for instance, would allow a full tax year to complete the transfer of any assets.

‘No gain, no loss’ pros and cons
If advantage is taken of the ‘no gain, no loss’ rules now, this could well store up trouble for the future. The ‘transferee’ will take on the asset at its original costs, which could result in a higher charge of CGT in any future disposal. If the transfer takes place after the year of full separation, then the market value rules apply to the transfer of any assets, irrespective of the price agreed.

Holdover relief
Holdover relief – deferral of Capital Gains Tax – may be available in certain circumstances, but be aware that the transferee will encounter the same potential issue as for ‘no gain, no loss’ – i.e. the asset will be received by the transferee at its original cost for CGT purposes. If a Mesher order is granted then this is likely to create a settlement and you should seek expert advice.

Some rules to remember
If a transfer occurs between spouses/civil partners after the end of the tax year of permanent separation, the ‘no gain, no loss’ exemption will not apply. This is due to rules to decide the date of disposal, and the amount of consideration on disposal. The information you will need includes:-

  • any decree absolute or dissolution of the civil partnership;
  • the court order if the asset was transferred by such an order, and
  • any other contract under which the asset was transferred.

The former matrimonial home
Private Residence Relief may be available for any gain arising on the disposal of the former matrimonial home. Spouses/civil partners can only have one residence between them for the purposes of the relief at any time while they are living together.

It is quite common for one spouse/civil partner to move out of the matrimonial home following the breakdown of the relationship. In this instance, the spouse (who has ceased to occupy the residence) then has 18 months to transfer their share to the other party without incurring CGT.

Transfer of shares
A transfer of shares between spouses/civil partners before the end of the year of permanent separation will be exempt from CGT under the no gain, no loss; rules, Again, be aware that if this exemption applies, the transferee would receive the asset at its original cost, which in turn, could increase the CGT on any future disposal.

Financial settlement under divorce proceedings may involve the extraction of funds from a company – for example, the disposal of shares by one party to meet lump sum payment obligations. There are no special exemptions that apply to these circumstances and the usual tax considerations will need to be thought through.

Speak to your tax advisor
The rules are complicated, to say the least, so speak to your specialist tax advisor, who will be able to provide guidance for your own specific circumstances.

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