The last thing anyone wants when going through a divorce is unexpected tax liabilities. We focus on some of the key tax issues that arise out of separations, and the pitfalls a spouse should watch out for when splitting assets.
Going through a divorce is usually a stressful, difficult and daunting process. Thinking about each other’s tax exposure in trying to reach an amicable agreement is not going to be at the forefront of people’s minds. This can be relevant for the division of assets and what to do with the family home. In such difficult circumstances, the last thing a spouse needs is to unknowingly assume new tax obligations as they start a new life.
Where the value of the assets is significant, we recommend you seek professional advice to make sure the division of assets is done in the most tax-efficient way. When preparing for negotiations on how assets should be divided and/or transferred, it’s vital to understand the tax exposure.
Capital Gains Tax (CGT): new rules
Currently, transfers of assets between spouses or civil partners don’t give rise to a CGT charge. The transfer happens no gain or loss.
But at the moment this rule only applies until the end of the tax year (5 April) after permanent separation. Transfers after the end of the year of separation are deemed to happen at market value and potentially give rise to a CGT liability. This is a very common situation as it can often take a long time to reach agreement on the division and transfer of assets.
Much depends on when a couple separates in the year. If it’s on 1 May, they will have until the following 5 April to transfer assets without triggering a CGT charge.
By contrast, if they go their separate ways in the first quarter of the year, they will have much less time before triggering a liability. For example, a couple separating on 1 March will have just over a month to transfer any assets.
But there is good news. HMRC has recently announced a sensible relaxation to these rules. From April 2023 couples will have up to three tax years to transfer assets between them. This is obviously a very welcome extension and will help ease the strain of divorce by giving more time to reach an agreement.
An important point to note is whilst couples who separate in the year after 6 April 2022 will automatically be within the scope of these rules, those who parted ways before 5 April 2022 must wait until after 6 April 2023 to transfer any assets if they wish to benefit.
The proposed legislation will also apply the ‘no gain or no loss treatment’ to assets that are transferred as part of a formal divorce agreement, even after the three year window. Again, this is a welcome relaxation of the current rule for couples with very complex affairs, where it will take a longer time to agree a way forward.
Inheritance Tax (IHT): when exemption applies
Transfers between spouses are exempt from IHT up to the date of the decree absolute (the court order that makes the divorce final). This is restricted to a lifetime limit of £325,000 for transfers made from a UK domiciled spouse to a non-domiciled spouse. But there is no restriction on the transfer from a non-domiciled spouse to a UK domicile.
Transfers of property made after the decree absolute may be exempt, if the transfer was not intended to confer any gratuitous benefit or is being made for the maintenance of the transferor’s family.
Any transfers not considered exempt are treated as a potentially exempt transfer (PET). This means when a transfer is made after the decree absolute, and the transferor dies within seven years, IHT may be due at up to 40%.
Don’t forget the Wills
It’s important to note that whilst marriage revokes an existing Will, this is not the case for divorce. The Will remains valid, but the former spouse will no longer be able to act as executor or inherit from the Will. Following a divorce, you should review or revoke any Wills to reflect your intentions.
The family home and CGT
For most couples, the family home is the main asset.
Usually there’s no CGT on the family home as it is covered by principle private residence relief (PPR). This exempts the property from CGT for the period they occupy it and for nine months after moving out.
This can create an issue where a spouse or civil partner retains an interest in the family home. The occupying spouse is exempt from CGT on any eventual gain on disposal. But the spouse who has moved out is subject to CGT on the gain they make for their share of the home, for the period they have not lived at the property.
The good news is that from April 2023 HMRC is planning to extend PPR to the spouse or civil partner who retains an interest in the former family home but has moved out.
Individuals who have transferred their interest in the former family house to their ex-spouse or civil partner are entitled to receive a percentage of the proceeds when that home is eventually sold. They can apply the same tax treatment to those proceeds, when they receive them, as applied when they transferred their original interest.
In practice this change should exempt most family home disposal proceeds from CGT, even where there isn’t an immediate disposal or retention of an interest.
For most tax purposes a couple remain connected until the date of the decree absolute. This also applies for Income Tax and non-domiciled remittance basis taxpayers.
This can present a particular risk for taxpayers who have used the remittance basis to keep foreign income and gains outside the UK tax net.
Where they have claimed the remittance basis the funds are only taxed if they are subsequently brought into, or used in, the UK. This could be by the original taxpayer or someone connected to them, including their spouse. So any relevant funds brought into the UK by the spouse, after separation but before the decree absolute, could create a liability for the original taxpayer.
This can be particularly problematic once a couple has separated, as it’s much less likely they will keep each other fully informed of their financial arrangements. But it is still possible for an estranged spouse to trigger a tax liability for their partner, possibly without even informing them.
You can manage this risk by agreeing that a transfer to the UK can only to be made after the decree absolute and by having separate provisions for the maintenance of children in the settlement agreement. It’s very important for non-domiciled taxpayers to take specialist advice when considering the division of assets on divorce.
Following the decree absolute, the funds can be brought to the UK by the spouse without triggering a tax liability, provided they are not used for the couple’s children if they are under 18.
How we can help
Couples going through separation should always give careful consideration to the following:
what tax liabilities may be relevant or arise, and on what assets
the timing of any division or disposals
how the assets are to be transferred.
Tax considerations can be important in prenuptial or postnuptial agreements, divorce and separation, and in financial provision for the parties and their children.
To ensure that any agreement or order on the division of assets is done in the most efficient way, we strongly recommend you take professional advice at the outset. The PKF private client team would be happy to answer any queries or provide advice on these issues. Please contact your usual PKF contact or Stephen Kenny.
If you are intending to move on from your business, the earlier you start planning the better. You may need to restructure and incentivise key employees. But generally getting all your ducks in a row takes longer than you think.