Both parties to a divorce should take professional tax advice at an early stage. Non-doms also need specific tax advice not covered here.
All references to marriages below equally apply to civil partnerships
Married couples living together
Transferring assets between spouses does not give rise to capital gains tax (CGT) or inheritance tax (IHT) as transfers between spouses can be made with no gain/loss arising.
Income may be treated as split equally for income tax purposes even if the underlying ownership of the assets is different. Tax savings can be obtained by careful use of the other spouse’s unused personal allowances and lower tax rates.
Married couples are treated as living together for tax purposes until they are:
separated under a court order or a formal Deed of Separation; or
separated in such circumstances that the separation is likely to be permanent.
Tax year of permanent separation
The married couple’s allowance and the transferable personal allowance are still available in the year of separation and until the divorce is finalised.
After separation, income will be taxed based on the underlying ownership of the assets, never equally between spouses. Advice will be needed where assets continue to be held between the couple, and the underlying beneficial ownership is not equal.
Assets can continue to be transferred between spouses at no gain, no loss. The recipient spouse will take on the original base cost for CGT and therefore possibly pay CGT on the full amount of the gain on a disposal at a later date. The no-gain no-loss transfer takes precedence over any actual consideration given.
Following the tax year of separation up to grant of decree absolute
The transfer of assets between the couple are treated as taking place at market value for CGT as the couple remain ‘connected’. The spouse exemption is, however, no longer available. This can give rise to a ‘dry’ tax charge where tax is payable but no cash proceeds are received.
However, transfers during this period do remain free from IHT.
After decree absolute
Ex-spouses will no longer be ‘connected’ for CGT. In general, CGT will be based on the actual consideration received. There are some exceptions to this, particularly where the transfer is under a court order or in fact a gift, resulting in the market value rules continuing to apply.
As they are no longer married, gifts between ex-spouses are no longer exempt from IHT. Instead, rules apply to any transfers made between them which apply to any other individuals, that being that should a gift be made and the transferor then dies within seven years of making the gift, the gift may be subject to IHT at that point. The transferrable IHT nil rate band and the extension to residential property will also no longer be available.
Maintenance payments are not taxable in the hands of the recipient and likewise are not deductible for income tax purposes for the payer. Maintenance payments do not affect any benefits claimed (including child tax credit).
One of the couple may well leave the matrimonial home which is then transferred to the remaining spouse. From separation, the leaver can continue to claim CGT private residence relief on the home for a brief period (usually 18 months, reducing to 9 months from 6 April 2020) as well as being able to claim private residence relief on a new home. This private residence relief often exempts the whole of the gain on the property.
The additional 9 months relief may be available for the departing spouse for a longer period of absence if specific conditions are met, including that he or she does not elect for a different property to become the main home.
Transfers of a property under a court order granting divorce, nullity of marriage or judicial separation are exempt from stamp duty land tax.
It is common for the business partnership of a couple to be dissolved on divorce or for one of them to retire from the business. This this may give rise to tax charges, particularly where it is necessary to extract capital from the business. It may be possible to defer CGT on transfers, but there is no such relief for income tax.
Where the couple jointly owns a company, CGT on any transfer of shares after the year of separation may generally be deferred if the company is a trading company.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on www.smithandwilliamson.com prior to the launch of Evelyn Partners.