Break It Up: Tax on Separation and Divorce
The division of marital assets is a difficult time for most couples undergoing separation/divorce/dissolution, and little thought may be given to the potential tax implications that can arise. This article seeks to highlight some of these tax issues, and potential planning to help mitigate the potential tax charges and ensure that a larger pool of assets remains for apportionment between the parties.
Capital Gains – Tax Year of Separation
The transfer of assets between spouses/civil partners who are ‘living together’ in the tax year, is at no gain/no loss for capital gains tax. Individuals will be treated as living together unless they are separated under a Court Order or formal Deed of Separation, or they are separated in circumstances in which the separation is likely to be permanent. Provided that the partners were living together at some point in the tax year, then this principle applies until the end of the tax year of separation.
Therefore in practice, where a divorcing couple separate on say the 31 May in the tax year, and on/before the next 5 April, a property is transferred from one former spouse to the other, then this would not give rise to a capital gain/loss in the hands of the former spouse who has disposed of their interest in the property.
However, where the same property is instead transferred on 6 April, the transfer is outside of the tax year of separation and a capital gain/loss could arise on the former spouse who has disposed of their interest in the property.
Please note that this no gain/no loss principle does not extend to individuals who are not married or not in a civil partnership.
Private Residence Relief
A significant asset in many divorces is the marital home. Private Residence Relief (PRR) provides relief from capital gains tax for properties that are an individual’s only or main home, for periods where the property is lived in (or deemed to be lived in) as the main residence. A married couple who are ‘living together’ may have only one main residence for PRR.
The issue that can arise on divorce/dissolution is that one spouse/civil partner will move out of the marital home, and so the property is no longer being utilised as the main residence by the departing partner, for the purposes of PRR.
If the property is sold within 9 months of the departing spouse/civil partner leaving the property, then this period should still be covered by PRR.
If the property is sold outside of the 9 month period, then PRR may still be available for the whole period between the spouse/civil partner leaving the home, and the disposal of the property. All of the following conditions must be met for this relief to apply:
- The transfer is being made under an agreement between the spouses or pursuant to a Court Order;
- In the period between the departing spouse leaving the property and the disposal to the former partner, the former partner continues to use the property as their only or main residence; and
- The disposing partner must not have made a PRR election for another property in the relevant period.
The departing spouse/civil partner will therefore need tax advice before making any PRR main residence election when leaving the martial home.
Rationalisation of Property Interests
The marital assets may include other jointly owned properties aside from the marital home. It may be decided that these property interests should be partitioned between the former partners such that each of the partners wholly owns their own separate properties, rather than a joint interest in each of them. This will therefore involve the disposal of property interests to one another, which may have CGT implications.
However, specific relief is available where there is an exchange of joint interests in land, to allow any relevant gains to be rolled over into the interest that is acquired i.e. there is no gain/no loss.
However where the exchanges are of unequal values, part of the gain may still be chargeable, for the party acquiring the larger interest.
A demerger is a term used to describe the division or partition of a company and it’s underlying assets. It can be a useful tool in cases where spouses/civil partners have shares in a company that owns investment properties and/or separately identifiable trades.
Where the company can no longer continue effectively under joint ownership between the divorcing parties, then it might be decided that one party disposes of their shares to the other as a part of the divorce. However the party disposing of their shares may suffer CGT, especially if the company/shares are of significant value.
Alternatively, it may be decided that the company assets (e.g. properties), should be distributed between the shareholders (i.e. divorcing couple). However, the company will have tax to pay on the capital disposals, and further tax may be payable by shareholders on receipt of the distributions.
An effective demerger can allow the company to be split into to two separately owned companies, each with a share of the company assets or trade(s). Each former spouse can then continue their respective businesses via their new companies, independently from one another. Importantly, with proper planning and tax clearance, a demerger can be achieved without incurring charges to CGT, income/corporation tax, SDLT, and potentially stamp duty, which makes it a very tax effective solution.
The division of martial assets on divorce can result in charges to tax, reducing the overall assets available for each of the divorcing parties. However with proper planning, it may be possible to navigate around some of these potential tax charges, and achieve a better result for all parties involved.