As a relationship begins to break down, tax is unlikely to be at the front of anyone’s mind. Nonetheless, it’s worth considering the potential tax liabilities when negotiating financial settlements. Your lawyer will need to work closely with your tax adviser during this process to avoid any unexpected tax obligations.
Capital Gains Tax (CGT) principles
The general rule for Capital Gains Tax (CGT) purposes is that when an individual makes a gift of a capital asset to another, it’s treated as having taken place at Market Value (MV). However, when the transfer is between spouses or civil partners living together, a special rule deems these transfers to take place for a consideration that gives rise to no gain and no loss.
CGT in the tax year of separation
A couple may be separated by agreement or by a Court Order, or simply in circumstances that are likely to be permanent. They can still be ‘separated’ while occupying the same home if they’re living their lives free of each other’s marital control.
For CGT purposes no-gain-no-loss rules continue for the tax year of separation, ie until 5 April following the date of separation.
With an amicable divorce, where there’s agreement concerning asset transfers, it may be possible to complete the transfers before 5 April ensuring the no-gain-no-loss treatment is available. This ensures that no CGT would be due by the donor of the asset. The recipient of the asset will inherit the donor’s base cost for any future disposal.
CGT after separation
In practice, such early transfers of assets are unlikely, even in an amicable divorce. Separated couples remain ‘connected persons’ up to the date of the Decree Absolute, which means that transfers between them will take place at market value until then. The donor will therefore be liable to CGT on any gains and the set-off of any losses made will be restricted to future gains in transactions with the same person.
After the Decree Absolute, transactions between them that result from agreement of a financial settlement will be treated as made for consideration. Outside of that, transactions may be treated as arising for market value to the extent that they’re not bargains at arms-length.
The sale of the matrimonial home
For many couples, the main asset will be the matrimonial home which may need to be disposed of as part of the divorce with the proceeds divided between them. The key concern here will be if one of the parties has left the property and is living in new accommodation.
A normal disposal of the matrimonial home would likely have the availability of Principal Private Residence (PPR) relief. However, this could be restricted by the size of the grounds or by having multiple properties. There are various rules to qualify for PPR relief, this is then based on periods of occupation, deemed occupation and other qualifying periods. Full PPR relief would mean there isn’t liability to CGT on the disposal. In addition, a qualifying PPR property will also have the availability of deemed occupation for the final nine months of ownership.
An individual can only have one qualifying PPR property at one time (an election can be made where more than one property is held). Where one party moves out of the matrimonial home into a new property, and the marital home is not sold within nine months, there may be tax implications for that party on the disposal. Conversely, where the other party remained in the home up until the disposal, they may not be liable to CGT on any of the disposal.
The transfer of the matrimonial home
As part of the divorce proceedings, one partner may receive full ownership of the matrimonial home. It’s likelythat this transfer of the interest in the property would take place at market value, however, it could be treated as for actual consideration in a financial settlement.
It’s generally established that where a transfer of a share in a property which includes the right of occupation of the residing spouse a 15% discount can be applied to the value.
For example, if the property was valued at £1m, the MV of the half share would be £500,000. Discounting this by 15% would mean a taxable transfer value of £425,000. If this was transferred within nine months of moving out of the matrimonial home, this disposal could be covered by PPR relief. Should this be longer, an election can be made for the matrimonial home to be treated as their PPR, however, this may affect future PPR relief available if they’ve moved into a second property.
Inheritance Tax (IHT)
The transfer of assets between spouses and civil partners is exempt for IHT purposes up until the Decree Absolute.
After this date, any transfers between these parties may qualify for other reliefs but, if not, are treated as Potentially Exempt Transfers and there can be IHT consequences should the donor die within seven years.
If working through an amicable separation, it will be in the best interest of both parties to agree on at least some of the assets that need to be transferred before 5 April. Where this isn’t possible, it’s essential to be aware of the various tax implications of transferring assets and seek professional advice.
Article written by Phil Clayton in our London office.