When a marriage breaks down, tax is likely to be the last thing on the mind of either party as they try to resolve practical, financial and emotional differences.
However, without consideration and careful planning, tax can rear its ugly head at the most inconvenient moments and significantly add to the stress of an already difficult situation. Outlined below are some of the most common scenarios encountered during divorce proceedings when tax can become an issue.
In the years up to and including the tax year of separation, assets transferred between spouses/civil partners are done so on a "no gain/no loss" basis. This means that no Capital Gains Tax (CGT) is paid on the transfer, even if the asset has risen considerably in value since acquisition. Assets are therefore transferred at their base cost and not at market value.
Following the breakdown of a marriage, the rules continue to apply up to the 5th April following the date of separation. However, after this date, transfers of assets are subject to the usual CGT rules. The sting in this particular tail is that until the Decree Absolute is issued, the separated spouses/civil partners are still considered as "connected persons" for CGT purposes, and therefore the value of any assets transferred will be equal to the market value rather than the actual consideration paid.
If any assets are transferred at a loss at this point, then that loss becomes "clogged"; i.e. it may only be offset against gains made on transfers to the same connected person. After the issue of the Decree Absolute the connection ceases, the loss may therefore no longer be used and is effectively wasted.
Family lawyers will therefore be alert to ensure that, insofar as transfers of properties between separating spouses can be agreed, this is carried out before 5th April. Take for example a couple who jointly own a portfolio of rental properties that they intend to divide post-divorce; the potential tax payable could be a game-changer in reaching an overall settlement.
The most common (and usually the single most valuable) asset to be transferred between spouses/civil partners is the marital home, and so these rules are particularly pertinent in these cases. If a property has been occupied throughout its ownership as the main residence of the owners then relief from CGT is available in the form of Principal Private Residence Relief (PPRR). At present, when one party ceases to occupy a property as their main residence they can still claim PPRR against any chargeable gain for not only the period of occupation, but also for a period of up to 18 months afterwards. This affords the client some leeway to make arrangements to transfer the property without incurring a CGT charge. However, the government has proposed that from 6 April 2020 this additional period will be reduced to only 9 months in most cases, leaving taxpayers a much shorter period in which to arrange their affairs, and makes them considerably more exposed to a possible CGT charge. Although this is at present only a proposal, it’s expected to take effect from the proposed date. This has potential to cause particular difficulties for separating couples where one party permanently moves out of the family home and takes some time before they seek legal advice.
In addition, currently any chargeable gains arising on residential property transfers are generally notifiable to HMRC via a self-assessment tax return due by 31 January following the end of the tax year in which any transfer took place. Any tax due on such a transfer is also due for payment by this date. For example, the CGT due on a transfer taking place on 1 November 2019, during the 2019/20 tax year, wouldn’t be payable until 31 January 2021 leaving the taxpayer significant time to raise any necessary funds in order to make payment. However, from 6 April 2020 taxpayers will have to notify HMRC of any chargeable disposals of UK sited residential property within 30 days of completion of the transfer by submitting an online "residential property return" and making a payment on account of any tax due within the same 30 day period. In the context of a separation or divorce, this reduces the liquid capital immediately available and doesn’t allow time to regroup and rebuild before the tax bill arrives.
CGT on the sale or transfer of residential property is charged at either 18% or 28% of the gain, depending on the level of the taxpayer’s other income. An annual exemption is available to reduce the gain which is currently £12,000 (for 2019/20) and relief may be available for various costs such as legal fees and capital improvements to the property. As always: if in doubt, professional advice should be sought before making any decisions.
Published: October 2019
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