When it comes to the division of assets during a divorce, the tax implications can have a major impact. These should always be considered carefully, and specialist advice taken, to ensure an appropriate settlement between both parties.
Inheritance tax (IHT) and Capital Gains Tax (CGT) are the two main taxes that should be considered when any asset is transferred. Whilst transfers between divorcing spouses are regularly exempt for IHT, under the existing rules, there can be unexpected CGT implications. Today’s Autumn Statement has confirmed changes to these CGT rules which are explored below.
Current CGT on separation
For current transfers between spouses in connection with a divorce, it is often best for a transfer to take place within the tax year of separation. This is because it will be at no gain/no loss, deferring any CGT and this mirrors the tax position they have enjoyed during their marriage. Transfers after the tax year of separation, is another story, and CGT can be frustratingly triggered.
For example, if a married couple, Penny and Benjamin, separated in September 2021 (2021/22 tax year) and their assets were transferred as part of the matrimonial proceedings in November 2022 (2022/23 tax year), the transfer has taken place after the end of the tax year of their separation – so there will be CGT to think about.
Given the protracted nature of most divorce proceedings, asset transfers often take place after the tax year of separation. This can be exacerbated where the separation takes place in say, March, towards the very end of the tax year.
Principal private residence (PPR) relief
PPR relief can exempt any gain in value on property, i.e., where you have always lived and occupied as a home. There is a further potential CGT mismatch where the jointly owned family home is involved in divorce.
For example, Jessica moved out of the family home in January 2020, and she continues to own half the property. Michael and the children remain living there under a 2021 court order, whilst the children continue their full-time education until 2025. The family home is then sold in 2025, and Michael will enjoy full PPR relief as it has been his main home throughout his period of ownership. There is a problem for Jessica, however, as she did not occupy the property for part of her ownership period, so she by contrast will have CGT to pay on the gain from 2021 until 2025.
The new rules for transfers from April 2023
New rules were announced earlier this year following consultation with the Office of Tax Simplification (OTS) and have been confirmed in the latest Autumn Statement.
There has been an extension of the no gain/no loss period to three years after the end of the tax year of separation. Looking at the example above, for Penny and Benjamin, where the separation was in the 2021/22 tax year, so long as the assets are transferred before 5 April 2025 there will now be no CGT. The rules go further where there is a formal divorce settlement, and the no gain no loss period can be extended beyond the three years.
It is still important for CGT to be taken into account during the division of assets, as the CGT is deferred rather than exempted, with the party receiving an asset encumbered with a future CGT bill. For example, shares purchased by Benjamin for £100k are transferred to Penny in December 2024, when the shares are worth £250K. There is no CGT on the £150K gain as the transfer is at no gain/no loss but Penny inherits Benjamin’s £100K purchase cost, rather than the value at the date of the transfer (£250K). Penny then sells the shares in December 2026, when they are worth £380K. Penny would have CGT to pay on the £280K gain (£380K less the original £100K). As you can see, Benjamin’s CGT on £150K deferred in 2024, should be factored into any matrimonial negotiations as this will become taxable on Penny instead.
The rules for PPR have also been revised and help the PPR example above, with Jessica now receiving PPR relief on her full gain on the family home, even though she did not live in the property between 2021 and 2025. Assuming Jessica buys a new residence, she should be aware that PPR cannot be applied to two properties simultaneously. In these circumstances you should still consult with your adviser to determine which property may benefit from the most PPR relief and whether a formal election is required.
In many cases it may be worth delaying the transfer of assets under matrimonial proceedings until after 5 April 2023, to take advantage of the new rules. The key here is to take advice on the tax implications of transferring assets and the timing of any transfer and in certain cases for the court to appoint a single joint expert to help both parties reach a swift and equitable resolution.
If you are in the process of a separation or divorce and need some advice on tax implications, please do not hesitate to contact Henry Lowe or a member of the Private Client team.