Tax is not always top of the list of our clients’ concerns. However, couples with even quite modest assets can find themselves having to pay a substantial CGT bill when assets are sold or transferred as part of a divorce settlement.
In many cases, incurring some liability is unavoidable. However, with some careful planning, couples who are separating or getting divorced can avoid paying more than they need to. Timing can be crucial. As we enter February, the end of the current tax (5 April) is getting closer, which can be significant.
Tax is really complicated and professional advice is a must in all but the simplest cases. Spouses and civil partners can transfer assets between themselves without incurring a CGT liability. This changes when they separate permanently and only applies to the period between separation and the end of that tax year. Not all couples can (or need to) take advantage of this rule but it is an essential consideration.
HMRC are also planning to change the “final period exemption” for private residence relief from 18 to nine months from 6 April 2020, which could have implications for spouses and civil partners moving out of the family home upon divorce or dissolution.
For more details, keep reading.
Capital gains tax (CGT) – an overview
CGT is one of less prominent taxes. The rules are very complicated but, in a nutshell, if you sell or transfer certain assets you may have to pay tax on any increase in value since you acquired them.
For example, you bought a holiday home for £100,000. You sell it for £200,000. You made a profit of £100,000, which is potentially taxable. HMRC will take into account the costs of acquiring and disposing of the asset – things like solicitors’ fees and stamp duty. Individuals also have an annual tax-free allowance (currently £12,000).
The rate of tax charged will depend on the amount of income tax you pay. Higher rate tax payers will pay 28% tax on gains relating to residential property and 20% for other assets. Basic rate tax payers will pay 18% on gains relating to residential property and 10% for other assets. If capital gains plus taxable income tip over into the higher rate threshold then the rate will be 28/20%.
I thought transfers between spouses/civil partners did not incur a CGT charge
In simple terms, spouses and civil partners who live together do not pay capital gains tax when they transfer assets between each other. Any gains will generally be taxed once either party sells or transfers the asset to a third party. Once they are permanently separated, however, only transfers between spouses that take place in the tax year of separation qualify for this “no gain / no loss” treatment.
This means that if you wish to transfer certain assets between you following separation, you only have until the end of that tax year to do so without incurring an immediate charge to CGT. People who separate in March therefore have less time to undertake transfers tax efficiently than those who separate in May – you get the idea.
Agreeing a financial settlement on divorce can take a long time and it is possible that the parties will need to engage in some kind of dispute resolution, whether that be mediation, arbitration, private FDR or a court process. For many, it simply isn’t feasible to transfer any assets during the period between separation and the end of the tax year. However, in cases where there is cooperation between the parties, it may be possible to undertake some transfers, even before a final agreement has been reached in order to lawfully mitigate the parties’ tax bill.
Do you have to pay CGT on everything you sell or transfer?
Many assets can be transferred and/or disposed of without incurring a CGT liability under any circumstances. These include gilts and premium bonds, cash, and assets held in an ISA. However, CGT will be due upon the transfer of assets like property other than your main home, personal possessions worth over £6,000 (other than your car), shares and business assets.
There are many reliefs and special conditions applicable to certain types of asset, particularly business assets. These can work to reduce, defer or eliminate liability to CGT in certain circumstances. However, the rules are far from straightforward so if you are disposing of an asset that could potentially give rise to a charge to CGT, we always recommend taking specialist tax advice.
Private residence relief
I mentioned earlier that you do not have to pay tax on the disposal of your main home. If you are selling or transferring your family home, in most cases, you will not have to pay CGT. This is due to a relief called private residence relief. As with all things CGT, the rules around the relief are complex and there have been literally hundreds of rulings on what constitutes a “main home”. This can be a very contentious area.
One point that can be highly relevant for someone exiting a marriage or civil partnership is something called the final period exemption. This means that provided a property has been treated as a person’s main home at some point, the final 18 months of ownership are deemed to qualify for private residence relief, whether they are actually living there or not. The relief was designed to allow people who bought a new home but struggled to sell their old one to remain outside the scope of CGT.
It is understood that the final period exemption is to be reduced from 18 to nine months from 6 April 2020. This means, for example, that someone getting divorced will soon only have nine months to sell the family home and receive the proceeds of sale without incurring any CGT liability if they no longer live there. It is worth remembering that private residence relief would still be available for the period for which it was actually the main home of the person no longer living there, plus the final nine months. Nevertheless, timing can plan an important role.
Other reliefs and elections may be relevant in the divorce context and it is therefore so important to have an overview of the tax position from an expert so that the tax implications of all options are known before final decisions are made.
How can I find out more?
The HMRC website section on CGT is a great source of information. However, as so often it’s a question of knowing what to do with all this information. As solicitors, we are not tax experts. For that reason we work closely with our clients’ existing accountants and tax advisers or, if a client has not previously taken tax advice, make a referral to a tax adviser who really understands tax in the context of divorce and separation.
In other (CGT) news
Reports abound that the government may be planning to restrict entrepreneurs’ relief in the next budget. At present, qualifying individuals benefit from reduced CGT when disposing of their business, subject to a lifetime limit of gains of £10m. Possible restrictions could include a tightening up of the qualifying conditions or a reduction of the lifetime limit. Entrepreneurs’ relief can be a valuable tax-break in the context of divorce if a family business is being sold or transferred as part of a financial settlement.
Critics of the relief point to a lack of evidence that the relief does in fact stimulate people to launch start-ups. Supporters say that entrepreneur’s relief fosters a business-friendly climate, which is to be encouraged. We’ll just have to wait and see on Budget Day (11 March 2020) what this new administration has in store for all of us.
Getting tax right
The tax system is complex and there is rarely one obvious answer that ticks all boxes. The key thing is for our clients to understand the taxation implications of the various financial arrangements possible after divorce, bearing in mind that mitigating their liability is an important, but not the only, consideration.