Changes to divorce law mean it’s crucial that complex tax rules are followed carefully to avoid a heavy tax bill. The new ‘no fault’ divorce which came into effect for separating couples from April 2022 has seen the number of divorce applications nearly double compared to the same period last year.
New No Fault Divorce Triggers Tax Issues
From April 2022, the Divorce, Dissolution and Separation Act 2020 was reformed to remove the necessity for fault. Couples are now able to apply for divorce without the need to prove fault. This removes the challenging need to apportion fault, for couples who wish to separate on their own grounds. This allows divorcing couples to focus on key practical decisions, regarding children, finances and the future. Despite this, it is absolutely key to consider the implications of tax liability to minimise what you owe, as you should with any financial partnership. Here is what you need to know.
Capital Gains Tax
Couples who are married or in a civil partnership and live with a spouse / civil partner, then any transfer of assets between you will not usually give rise to a taxable gain. However the date of separation is really important and a capital gains tax bill could be due if not properly executed. For tax purposes, any transfer is regarded as taking place at a ‘no gain, no loss’ whereby the recipient inherits their 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 6 April 2022 while you still may be legally married or in a civil partnership, the ‘no gain, no loss’ rule will no longer be applied after separation, however you will be deemed to be ‘connected persons’ for CGT purposes.This means that a transfer of assets take place at market value, which may cause a liability to pay capital gains tax even though there has been no monetary transfer.
Private Residence Relief
There are potential tax consequences when the family home is either sold or transferred as part of a divorce. Private residence relief (PPR) may be applied to the gain arising on disposal/transfer where the property is, or has been used as your only or main residence, at some point. You cannot have more than one main residence between you for the purpose of this private residence relief. Following the tax year of separation, each partner is entitled to nominate separate properties which they will consider their main residence for PPR purposes.
Transfer of Property
When a partner leaves the shared home and transfers their share of the property to the remaining party, PPR is always available for the last nine months of ownership. This means that no CGT will be payable if the transfer is within nine months. This may be extended if the leaving partner transfers their interest in the property to the remaining partner, under court order. In this case PPR relief will be extended from the date the transferor moved out until the date of transfer, if the transferee has continued to occupy the property throughout the period since the transferor left, This is not available if the transferor has nominated another property to be their main residence. Such a claim only if the property is transferred and not sold.
Business Assets and Hold-Over Relief
If an asset is transferred from one partner to another after the tax year of separation, it is deemed to take place at market value. Hold-over relief could be available for a ‘qualifying business asset’. This allows a capital gain to be held over against the base cost of the asset, reducing 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. Attention needs to be given when considering the availability of hold-over relief. HMRC considers transfers made under a divorce settlement are not a gift and consequently hold-over relief will not apply.
Transfers between partners are usually exempt from inheritance tax (IHT). Known as ‘the inter-spouse exemption’, a rule which continues during the period of separation until Decree Absolute is granted. If one partner is non-UK domiciled, the interspousal exemption is limited to under £325,000. Transfers which are made after the Decree Absolute, under the terms of the court order, may still be exempt from IHT where there is no intention of conferring any gratuitous benefit on the recipient. Maintenance payments made to a former partner should also be exempt from IHT. Divorce does not revoke an existing will. We recommend that you review your will following divorce.
Transfers between partners under a court order are not liable for income tax. However income tax is due if you receive any income-producing assets from your former partner, such as shares or interest-bearing bank accounts. You may need to file a self-assessment if any such income is above the relevant thresholds. It pays to take good advice as early as possible. Especially for couples who have waited to take advantage of the no-fault divorce. It’s in the best interest of both partners to ensure assets are distributed in the most tax efficient way.
At Prestige Business Management we can help your Business
At Prestige Business Management we can help you understand and manage your capital gains tax planning. Find out what we can do for you. Call us today on 0203 773 2927.