Many clients who come to us for advice following the breakdown of their relationship are business owners. Further, it’s not uncommon for spouses or civil partners to be involved in business together, whether both are in active roles or where one spouse or partner has a more passive role in the business, perhaps for tax reasons. Civil partners are treated the same as a married couple for tax purposes and therefore reference to a spouse or spouses in this article should also be taken to include civil partners and reference to a divorce to also cover a dissolution of a civil partnership.
Contrary to popular belief, there’s no general tax exemption for a couple when they get divorced. However, the date that an asset is deemed to have been transferred can have an impact, so the timeline of divorce petition, financial order (and the drafting thereof) and Decree Absolute will be relevant.
How business interests are dealt with prior to, upon and following a separation can have a significant impact on the individuals’ and a company’s tax positions so it’s very important that expert tax and family law advice are taken at the earliest opportunity, and certainly before any big decisions are made or reactive changes are implemented.
Business assets can potentially be used to fund a financial settlement upon divorce. Where both parties are directly linked to the business, whether as owners and/or as employees, it’s often the case that following the breakdown of their relationship, there’s a desire at least on the part of one of the pair for themselves or the other to be extricated from the business, leaving the remaining individual to move forward independently with the business.
Tax advice (and possibly employment law advice) should be taken prior to and alongside negotiations in respect of the financial settlement pursuant to the parties’ separation so that those negotiations can be fully informed as to all the foreseeable consequences of settlement options. This is likely to include: looking to maximise the availability of reliefs such as Entrepreneurs’ Relief; choosing what’s to be liquidated; and when.
Options such as a director taking a loan from the company, or a shareholder taking a dividend, may be considered, where those funds are to be applied to pay, for example, a lump sum to a spouse as part of a wider financial settlement. Yet the tax implications can be considerable. For example, corporation tax paid on an overdue director’s loan repayment is 32.5% at present, so a director may choose to borrow a significant amount from the company in the short term but should be confident of being able to repay it quickly and within the terms of the loan.
If retained profit is to be used for funding a settlement then the favourability of how best to apply that retained profit should be considered. For example, if it’s paid out as salary or dividend then it reduces the taxable profit of the business, but increases the income tax liability of the individual.
If sufficient cash is available to be paid over at completion of a share transfer, it may be worth considering extracting capital from a trading company (or holding company of a trading company) by way of a company purchase of own shares. As an alternative, extraction of funds in capital form by using a new company could be an option – i.e. the new company purchases both spouses shares. The spouse who is to continue in the business gets shares in the new company in return and the exiting spouse gets cash/ loan notes. There are disadvantages to this option, which include stamp duty.
Where shares are to be sold or transferred, CGT liabilities should be considered. Whether the transferor was employed by the subject company, and the size of the transferor’s shareholding, will be key to whether or not Entrepreneurs’ Relief will be of use. Ensuring the criteria for Entrepreneurs’ Relief remain in place at the relevant time should not be forgotten. For example, a disposing spouse shouldn’t quit as an officer or employee of the company before the transfer takes place
Perhaps of most pressing and significant concern in relation to CGT is the fact that current regulations provide for disposals between spouses that are made in the tax year of separation to be treated as made at neither a gain or a loss – therefore no CGT is due. This provides for a potential tax saving and therefore retention of what may be very much needed family capital that can be applied to the parties to help fund their respective new lives. The date of separation (and the evidence of this) is very important. The relevant assets would be transferred pregnant with the gain, but the aim would be to look at that as part of later settlement discussions.
Section 165 of the Taxation of Chargeable Gains Act 1992 means that a transfer of shares from one spouse to another, not in exchange for money, could be covered by gift (holdover) relief, as long as the gift is made pursuant to a court order. Once again, the transferor wouldn’t be liable to any CGT on the transfer, but the transferee would receive the shares pregnant with any gain.
Where one party is less au fait with the operations and finances of the relevant business, help and advice should be taken to review and interpret the business’ accounts. For example, reference to ‘taxable profit’ does not necessarily equate to profit that will be taxed.
Sometimes, ‘family’ assets, such as the family home, are owned by the family company. It’s possible for assets, rather than just cash, to be transferred out of the company as a dividend. The tax consequences of such a transfer should also be considered.
If there are different businesses/ trades under one company’s/ companies’ umbrella, and each spouse wishes to continue with their area, demerger may be an option. However, this can be complex from a tax perspective, and generally reorganisation requires a high level of co-operation between spouses.
In summary, there’s no all-encompassing tax exemption on divorce, but there are plenty of tax reliefs if you know where to look, so get advice before you act; don’t make divorce any more taxing than it already is!
Published: August 2019
A monthly briefing from Irwin Mitchell Private Wealth
August 2019
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