From April 2022, the Divorce, Dissolution and Separation Act 2020 has reformed the divorce process to remove the concept of fault. Couples are now able to apply for divorce without having to prove fault, ending the blame game and allow divorcing couples to focus on key practical decisions regarding their children, finances and the future.
In this article we have summarised some of the key tax issues to consider.
Timing is extremely important when considering the transfer of assets between divorcing couples. If you are married or in a civil partnership and live with your spouse/civil partner, then any transfer of assets between you will not usually give rise to a taxable gain. For tax purposes, the transfer is treated as taking place at a ‘no gain, no loss’ whereby the recipient inherits their spouse’s/civil partner’s original cost. This rule extends to the tax year of separation, but only if you lived together at some point in the tax year.
From the 6 April following separation, while you still may be legally married or in a civil partnership, the ‘no gain, no loss’ rule will no longer be applied, however you will be deemed to be ‘connected persons’ for CGT purposes. This means that any transfer of assets will be deemed to take place at market value which may mean you are liable to pay CGT even though no cash has exchanged hands.
It is important to consider the potential tax consequences when the family home is sold or transferred as part of a divorce.
PPR may be available on the gain arising on disposal/transfer where the property is, or has at some point, been used as your only or main residence. If you are married or in a civil partnership, you cannot have more than one main residence between you for the purpose of this relief. After the tax year of separation, each spouse/civil partner will be entitled to nominate separate properties which they will consider their main residence for PPR purposes.
PPR relief is always available for the last 9 months before disposal/transfer if the property has been occupied as your main residence at some point during the period of ownership.
Transfer of property to occupying spouse
In some cases, the departing spouse/civil partner leaves the marital home and transfers their share of the property to the remaining party. As PPR is always available for the last 9 months of ownership, if such transfer is within 9 months, no CGT will be payable.
A special extension to this rule may apply where the leaving spouse/civil partner transfers their interest in the property to the other spouse under the Court Order. In this situation, if the transferee has continued to occupy the property as their residence throughout the period since the transferor left, PPR relief will be extended from the date the transferor moved out until the date of transfer.
Relief in this circumstance will not be available if the transferor has elected for another property to be their main residence. Furthermore, the claim can only be made if the property is being transferred and not sold.
If an asset is transferred from one spouse/civil partner to the other after the tax year of separation, it will be deemed to take place at market value. If the asset is a ‘qualifying business asset’, Hold-over Relief could be available. This relief allows a capital gain to be held over against the base cost of the asset, reducing/eliminating the immediate charge to CGT. However, when the asset is eventually sold the CGT will be much higher due to a lower base cost attributed.
Care must be taken when considering the availability of Hold-over Relief. HMRC’s view is that such transfers under a divorce are not a gift and consequently hold over relief will not apply.
Transfers between spouses/civil partners are generally exempt from IHT commonly referred to as ‘the inter-spouse exemption’, a rule which continues during the period of separation until Decree Absolute is granted. If one spouse/civil partner is non-UK domiciled, the interspousal exemption is limited to £325,000.
Transfers which are made after the Decree Absolute, under the terms of the Court Order, may still be exempt from IHT provided there is no intention of conferring any gratuitous benefit on the recipient. Furthermore, maintenance payments made to a former spouse or civil partner should also be exempt from IHT.
It is important to note that divorce does not revoke an existing will. We recommend that your will is reviewed following divorce and updated accordingly.
Transfers between spouses/civil partners under a Court Order are not subject to Income Tax. However, if you receive income producing assets from your former spouse such as shares or interest-bearing bank accounts, you will be subject to income tax on these amounts. You may need to file self-assessment tax returns if your income is above certain thresholds.
The tax consequence of divorce can be material, with many pitfalls to navigate. With that in mind, it is important that specialist tax advice is sought as early as possible to ensure assets are distributed in the most tax efficient way for both parties.