It’s a sad fact of life that in times of stress, relationships suffer and unfortunately this can sometimes lead to a couple divorcing. At that time, the last thing anyone is thinking about are the tax consequences which can be managed if addressed early on.
When you get divorced, the assets that you own together are usually split up, from the family home to the business you run together, as well as pensions and investments. Unfortunately, the protection from capital gains tax that married couples enjoy on transferring assets between themselves, ceases to apply on 5 April following the date that you separate. Moreover, often assets have to be sold to finance divorce settlements, which of course will trigger tax charges.
The key therefore is not only timing, but also working out early on what assets will trigger what tax charges when they are either transferred or sold.
In our experience, taking advice before taking the plunge, or in the very early stages of separation, not only helps you understand the family situation better, but can also save a large sum of money; money that is needed to support your lives going forward.
For example, the date you decide to separate can have a major impact on the tax treatment of any divorce settlement. Because transfers between spouses in the tax year that they separate continue to enjoy the spousal exemption, making them tax free, the loss of this on 5 April following your separation can be very expensive – especially as the transfers continue to be taxed as if they happen at market value. Whilst it can sound rather stupid, waiting to separate until 6 April is the soundest move from a tax perspective.
Of course, there are some common assets that families own and each have their quirks:
The Family Home
When an individual disposes of their main home, they usually do not pay any tax. This is because it qualifies for relief – known as Principal Private Residence relief (often referred to as PPR relief). However, usually when two people separate, one person moves out of the family home. When this happens, any future disposal of the former matrimonial home by the person who no longer lives there can attract capital gains tax. There are two reliefs that can apply:
First, PPR relief also covers the first 9 months after the person has left and begun living somewhere else.
Second, in certain circumstances which include the person who has left not moving into a different property that is their PPR, they can treat the former matrimonial home as their PPR for capital gains tax purposes.
Of course, rental properties and ‘second homes’ will not attract either relief unless either person lived in that property as their PPR for a period of time.
There is a silver lining though as there is no Stamp Duty Land Tax (SDLT) to pay if the transfer of a property is done as part of a Divorce Agreement. This only applies where the transfer is between the couple divorcing – third party sales will attract SDLT in the usual way.
The Family Company
Matters become more complicated when we consider shares in the family company (or indeed an interest in the family business). If these are transferred after the 5 April following the date of separation, capital gains tax will apply on the difference between the market value of the shares (or interest) at the date of the transfer and their original cost. As most family companies have nominal share capital (i.e. they are formed with say £100 of shares), the gain can be sizeable.
There are two main reliefs that can apply: business asset disposal relief (formally known as entrepreneurs relief) which reduces the rate of capital gains tax payable to 10% from the usual 20%, and a form of hold over relief that allows the gain to be held over against the asset being transferred. The latter can only apply where both parties agree, which may be difficult if things have become acrimonious.
The really challenging issue is arriving at the valuation of the business. This impacts two elements: first is the tax. Second is what the other party is entitled to if they joined the business after it had begun or it was only owned by one of the parties. There are a number of different valuation methodologies which can apply in these circumstances and care needs to be exercised in choosing the right one as it can and does make a big difference to the outcome.
When cash or other assets are transferred between divorcing couples overseas, there may not be any UK tax to pay even if the transfer triggers a gain, if the transferring party is able to rely on the remittance basis. However, extreme care needs to be taken to ensure that the payment does not itself trigger a remittance by settling a UK debt triggered by the divorce settlement.
It is worth saying that even though the transfer may not trigger a UK tax charge, it may trigger taxes in other jurisdictions. Local advice should always be sought in these cases.
The IHT position also changes significantly and divorce could negate any earlier tax planning that has been done. For example, any mention of a former spouse in a Will is ignored unless the Will is redrafted post-divorce. In amicable divorces, this may not be the intention, especially if this forms part of wider planning for the family.
In addition, all interspousal reliefs are lost, and the ability to transfer allowances also disappears. This could leave any children of the marriage or other beneficiaries with a higher tax bill one day where new plans are not put in place.
For further advice, please contact the CBW Private Client tax team.