Capital Gains Tax: Separation & Divorce

Introduction

HM Revenue and Customs published a policy paper on 20 July 2022. This provides for a potential change to the rules that apply to the transfer of assets between spouses and civil partners who are in the process of separating.

The family home is often the biggest asset in most divorce cases. Depending on the financial settlement, some divorcing couples chose to sell the property whilst others agree a transfer of ownership of the family home to one spouse.

No gain no loss

Transfers between married couples and civil partners who are living together do not attract capital gains tax (CGT). This includes a transfer of the family home but the position changes when couples separate.

There is a CGT “exemption” which means that transfers can be made between couples at “no gain no loss” at the end of the tax year in which separation takes place. This means that the base cost of the asset is inherited by the receiving spouse, so that the full amount of CGT will be payable when they subsequently sell or transfer the asset.

Sometimes couples believe that if they transfer an asset in the tax year of separation then there will be no CGT payable at all but as you can see this is incorrect as CGT may be payable in the future. It is however essentially postponed, and this can actually be very important in determining what is the net asset base of the divorce case because there still could be this tax liability to pay in the future and if this is not looked at properly it could mean that the financial settlement is unfair.

Following the tax year of permanent separation, transfers of assets between couples are subject to CGT in the usual way.

One of the problems of the current rules is that they arbitrarily favour couples separating earlier in the tax year. Most people do not seek legal advice until months after they had separated and by which time it could be took late to take advantage of the “no gain no loss” rules.

Private Residence Relief

Under the Private Residence Relief (PRR), homeowners do not pay CGT on their main home.

However, if following separation one spouse leaves the family home then they will be able to claim the full relief if they dispose of their interest within 9 months of leaving. But once this time period has passed they will only be eligible to claim for partial relief. This “final period exemption” was 36 months prior to April 2014, and then 18 months prior to April 2020, before being cut to just 9 months.

Because this time has been systematically reduced, it also means that it has become increasingly difficult for divorcing couples to make a decision about whether or not the family home should be retained in joint names, transfer to one party, or sold and all before the tax relief is lost. There would also need to be time to implement all of this.

Arguably even where the family home is being transferred into the name of one spouse, it appears likely that under the “no gain no loss” rule, whilst no tax would be payable at the point of transfer, the receiving spouse would inherit the other spouse’s chargeable gain (between the end of the period of exemption to the date of transfer) and which would be subject to CGT on the eventual sale of the family home, if the annual exemption did not apply.

30 day time limit for reporting disposals on property

The other main concern is that in April 2020 HMRC significantly reduced the period for reporting and paying CGT where tax is due following the disposal of UK residential property. In the past, property disposals needed to be reported and any tax paid by 31 January following the end of the tax year in which the disposal took place. However, since 6 April 2020, the timeframe is now only 30 days from completion.

The new proposal

The Office of Tax Simplification (OTS) reported about how the CGT rules apply to individuals who separate and divorce. The OTS recommended that:

“The government should extend the “no gain no loss” window on separation to the later of:

• The end of the tax year at least 2 years after the separation event. 

• A reasonable time set for the transfer of assets in accordance with the financial agreement approved by a court or equivalent processes in Scotland”

This policy objective is to attempt to make fairer the CGT rules that apply to spouses in civil partners who are in the process of separating and/or divorcing. It is to give them more time to transfer assets between themselves without incurring a possible CGT charge. In terms of a financial settlement on divorce this is clearly important because, for example, there would be more available money to meet the couples’ respective needs for housing together with any children.

This measure is to provide couples with greater time to deal with their assets as part of the divorce settlement when they cease to live together; and it also introduces some special rules to a spouse who has maintained financial interest in the former family home following separation and that apply when that home is eventually sold.

Where do we go from here: the proposed revisions

Legislation will be introduced in Finance Bill 2022 – 2023 that will provide that:

• Separating spouses or civil partners be given up to 3 years after the year they cease to live together in which to make no gain or no loss transfers.

• No gain or no loss treatment will also apply to assets as that separating spouses or civil partners transfer between themselves as part of a formal divorce agreement.

• A spouse or civil partner who retained an interest in the former matrimonial home be given an option to claim PRR when it is sold.

• Individuals who have transferred their interest in the former matrimonial home to their ex spouse or civil partner and are entitled to receive a percentage of the proceeds when that home is eventually sold, will be able to apply the same tax treatment to those proceeds when received that applied when they transferred their original interest or home to their ex spouse or civil partner.

Impact on separating or divorcing couples

The measure and proposed changes will make fairer the process for those spouses who are separating or divorcing and are in the process of distributing assets between themselves.

It is expected that the proposed changes will have a positive impact on individuals by extending the period of time available to give separating couples at least 3 years to make no gain or no loss transfers between themselves for CGT purposes.

This will be especially relevant to couples in complex divorce cases, as it means that more time can be spent on the divorce considerations, rather than just CGT in isolation.

Quite clearly, the time extension will also help avoid further depletion of household income or matrimonial wealth through tax charges on the basis that the divorcing couples can meet the new time periods.

Further advice

We can provide specialist family law advice to you during a separation or divorce (or in contemplation of this). We are specialists in matrimonial financial cases and financial settlements. Tax is a very important consideration but is often ignored or left until the last moment when it may be too late to avoid any tax charges as part of the divorce and financial settlement. It is also very important that you seek your own separate and independent tax advice from a specialist accountant.