CAPITAL GAINS TAX - 29.11.2017

The tax consequences of divorce or separation

Assets

Where a married couple have assets (shares, property etc.), it is common for these to be divided between them in the event of divorce, or even just a permanent separation. This can be decided by the individuals directly, or (if necessary) a court can order how the assets are to be split.

In either case, where assets are transferred, the position in relation to capital gains tax (CGT) needs to be considered carefully.

Spouse exemption

There is a well-known CGT exemption contained in s.58 Taxation of Chargeable Gains Act 1992 (TCGA) that treats transfers between spouses and civil partners (we use spouses collectively to refer to both) as being made on a “no gain, no loss” basis. What is sometimes overlooked is that this ceases to apply after the end of the tax year that permanent separation occurs - the date of the actual divorce is irrelevant for these purposes.

Example. Frank and Alice separate on 1 January 2018. By agreement, Alice transfers a share portfolio to Frank on 7 April 2018, in exchange for him signing over his interest in the house to her. The shares are standing at a gain of £50,000. The divorce is amicable and is finalised in October 2018. Unfortunately, as the date of transfer was after the end of the tax year of separation, Alice will have to pay CGT. If the transfer had been made two days earlier, it would not have been chargeable.

Pro advice. Scenarios like the one described underline why it is crucial to begin considering tax at the earliest opportunity. Ensure it is on your agenda as soon as you discover your clients are even contemplating splitting up.

Date of separation

Clearly, the date of separation is vital to establishing the point at which s.58 ceases to apply. Unfortunately, this is often subjective - especially in circumstances where a couple separate, but continue to live in the same property. Generally, the date will be:

• the applicable date of a separation by court order or deed of separation; or
• the date on which the couple separated in such circumstances in which it was likely to become permanent.

Pro advice. Look at dates when legal advice was requested, new tenancy agreements signed, or notice given to tenants of let properties to build up a trail of evidence to support the date of separation.

If the transfer is made as a result of a court order, the date of disposal will be the date of the order, unless it is made before the decree absolute, but the asset is not transferred until later. In that case the disposal date is taken to be the date of the decree absolute.

If you examine the evidence, but establish that s.58 cannot be utilised, you will need to review what other tax relief might be available.

Pro advice. For inheritance tax purposes, transfers are exempt right up until the date of the decree absolute, so do not take them into account when advising on the available nil rate band later on if they take place prior to that date.

Matrimonial home

Often, the most significant asset will be the property that the couple have been living in together. Where the property has always been the main residence, private residence relief (PRR) will be available. If the transfer takes place within 18 months of the date the transferor moves out, any gain will be fully exempt. However, if there have been periods of absence, or there is more than one property that has been used as a home, things will be more complicated.

Pro advice. Request details of all elections, and periods of absence - as some of these may qualify as “deemed” occupation, which will reduce any taxable portion of the gain.

There is an opportunity to mitigate any CGT where the disposal is more than 18 months after the moving out date. S.225B allows the transferring spouse to continue to treat the former home as their main residence right up to the date of transfer, or, if earlier, the date their spouse ceases to occupy it as their main residence.

If the transferring spouse has purchased another property before the transfer, a claim under s.225B will mean that the additional period covering the marital property cannot be used when calculating PRR in respect of the new property. You need to look carefully at which is likely to give rise to the larger gain to decide whether a claim is beneficial.

Further complications can arise where the home is subject to a Mesher or deferred charge order; we will consider these in a separate article. If there are multiple properties owned jointly, consider the possibility of claiming relief for exchanges of interests under s.248 .

Business assets

It is common following divorce for one spouse to wish to pursue a shared business interest alone. A settlement will therefore often include the transfer of an interest in a business, for example, shares in a company. HMRC guidance (see Follow up ) confirms that the business asset gift holdover relief given by s.165 applies where the transfer has been made in accordance with a court order, and there is no consideration (which is not restricted to money, or money’s worth) received.

Pro advice 1. Where entrepreneurs’ relief is in point, ensure no steps are taken which would see this lost, for example, resigning as a director or employee prior to the transfer.

Pro advice 2. Consider whether the company could utilise a share buy-back to help with the tax efficiency of the overall settlement. Using a payment subject to CGT instead of making it out of taxed income could reduce the overall tax impact.

Family companies

It is worth noting that where one spouse has shares in a family investment company, there is likely to be a restriction in the articles prohibiting shares from being transferred to anyone outside of the immediate family.

It is important to note that just because the shares themselves cannot be transferred does not mean they are not taken into account when considering the value of all the marital assets. If, for example, the family shares were the only asset, it is likely that the court would order the shareholder to pay over cash or other assets to an equivalent value of its determined share. This might require them to extract profits from the company, so your advice on how best to do this will be required. Remember, the amount specified in the order will need to be the after-tax amount.

Rollover relief

If a business interest is transferred and s.165 relief is not available, a taxable gain will arise. This could occur, for example, because the transfer was not made pursuant to a court order, or the spouse’s interest in an unincorporated interest was bought out by the one who will continue the business.

It may be that the transferring spouse wishes to start their own business; this is likely if they have had a significant input into the business, and have built up expertise in the particular field. In these circumstances, rollover relief could be used to defer the gain arising on the transfer of replacement assets.

To qualify, the new trade must commence not more than three years after the transfer of the interest in the old trade. Both the old and new assets have to be qualifying assets used in the trade (see Follow up ), and the definition of this excludes shares, so if the transfer was of shares in a trading company, no rollover relief is available, and alternative methods of deferral, for example EIS, SITR, would need to be considered.

HMRC guidance - assets transferred under court order

Rollover relief - qualifying assets