Proposed changes to Capital Gains Tax rules on divorce & dissolution set to make financial separation more flexible
The new proposals could provide a huge step forward in assisting separating spouses in parting ways in as tax efficient a manner as possible.
Considering the division of assets early in divorce or civil partnership dissolution, and taking appropriate advice, has always been critical, but especially so when considering the potential impact of Capital Gains Tax (CGT). A failure to transfer assets before the end of the tax year of separating (5 April) can result in an unexpected CGT bill on the transfer of assets at a later date.
As a broad basis, CGT is levied on the occasion of a disposal by an individual (to which UK tax is applicable) of a capital asset where the disposal value is greater than the acquisition cost and in relation to disposals between “connected” parties, the disposal is generally deemed to take place at market value. However, it has long been established that transfers between spouses (who are living together) are free of CGT.
S.58 of the Taxation of Chargeable Gains Act 1992 governs the application of CGT in relation to spouses who are living together. Moreover, s.225B TCGA deals with the disposal of assets in connection with divorce. Although both of the above provisions provide for a degree of relief from a CGT in limited circumstances, these reliefs consistently prove overly restrictive in modern separation/divorce situations.
Many couples going through separation do not take into account the tax implications and timing of the transfer of assets between them and some are hit with unwelcome and unnecessary CGT bills, at an already difficult time. It is as a result of this situation that the Office of Tax Simplification has recommended that the tax rules should be updated to reflect a fairer and more modern approach to separation and divorce.
As a reminder, the current CGT rules on divorce:
Transfers of assets before separation during marriage/civil partnership
No CGT arises. For example, if a husband transfers an asset to his wife that has increased in value, the wife stands in the shoes of the husband and is deemed to have purchased the asset at the same time and for the same price that the husband originally acquired it, so no capital gain or loss arises.
For example, if he had purchased a holiday home in his sole name for £310,000 and gave it to his wife when it was worth £360,000, he would be deemed to have disposed of it for £310,000 and she would have been deemed to have acquired it for the same amount, i.e. there is no CGT.
Transfers of assets after separation
The tax treatment of transfers after separation depends on whether the transfer occurs during the tax year of separation, i.e. before 5 April or after, and if after, whether it is made before the decree absolute/final order has been pronounced or after, as set out below.
Transfers during the tax year of separation
If the spouses/civil partners have lived together during a particular tax year prior to the separation (which is likely to be permanent) and a transfer is made between them before the end of that tax year (the tax year of separation), that couple can make transfers to each other at no gain/no loss as would be the position if they were married. So, for example, if a couple separate on 1 September 2022, they can transfer assets between each other at no gain/no loss on or before 5 April 2023.
Transfers on/after 6 April and tax year of separation before decree absolute/final order
Once permanently separated, the couple are considered to be ‘connected parties’ for CGT purposes until the date of decree absolute/final order. The effect of this is that any transfer is deemed to take place at ‘market value’ whatever price (if any) is actually paid and if the asset has risen in value, CGT will be paid by the transferring party, subject to any applicable annual exemption, relief or losses. So, for example, if a couple separate on 1 September 2022 but they do not resolve financial matters until June 2023, then it is after the tax year of separation (5 April 2023) then they will be considered connected parties for CGT until decree absolute/final order and the transfer will take place at market value.
So, if the husband in our example above was transferring the holiday home to his wife as part of the divorce settlement after the end of the tax year in which separation occurred, he would be deemed to have made a gain of £50,000 and would have to pay CGT on the gain (18% or 28% depending on whether he is a basic rate taxpayer or not) even though his wife has not in fact paid market value or anything for the property and he has not raised any sale proceeds from which to pay the CGT bill.
Transfers after decree absolute/final order
Transfers (i.e. any disposal of the property) after decree absolute/final order will generally be for actual consideration rather than market value (unless the transfer is not at arm’s length, which would include any gift).
No transfer but a sale after separation and decree absolute/final order
A situation may arise where spouses/civil partners own a family home jointly but agree that the primary carer should remain living in the property until a certain trigger point e.g. the youngest child turning 18 at which point the consent order states the house should be sold. There has never been a transfer so CGT hasn’t been a concern at that point, but say the parties divorce when the child is 14 and the no longer residing parent moves out of the property, when the youngest child then turns 18 and the property is sold, the primary carer should be able to claim principle private residence relief on the sale of the property so they have no tax bill. However, the parent who moved out can only claim the relief for the period they lived in the property and so may face a CGT bill for the gain on the property from the period they moved out to the sale.
Proposed new rules
The Government are proposing to introduce legislation via a Finance Bill in 2022/23 that, if enacted, provides for the following for all disposals that occur on or after 6 April 2023:
- Separating spouses or civil partners will be given up to three tax years after the tax year that they stop living together in which to make a ‘no gain, no loss’ disposal for CGT purposes (although this time period would end earlier if the court pronounces the final order/decree absolute, ‘no gain, no loss’ treatment will continue to apply without any time limit to any transfers between separating spouses or civil partners pursuant to a formal divorce agreement – see further below on this).
For example, if the couple separate on 22 August 2022, the ‘no gain/no loss’ rule will apply to any transfers until 5 April 2026 unless they are divorced before that date, in which case the normal relief for transfers within the tax year of separation (only) would apply, or indeed relief under s.225B which is far more restrictive, or potentially the further relief provided as set out in point 2 below.
This is effectively a relieving provision for couples that are treated as a tax unit rather than separate individuals (for the purposes of CGT only). It does not avoid tax on any later disposition of the asset transferred between the spouses/former spouses as the acquiring spouse inherits the base cost/acquisition value of the disposing spouse, but it is a practical and logistical tool ensuring that a chargeable disposal for CGT is not triggered as a result of financial arrangements on divorce (where possible and legitimate).
- The ‘no gain/no loss’ rule will apply to assets that separating spouses/civil partners transfer between themselves with no time limit, so long as it is part of a formal agreement (known as a consent order) within divorce or dissolution proceedings that is approved by the court or via a court order made within financial remedy proceedings. The current position limits no gain/no loss CGT treatment to the tax year of divorce only.
The position therefore would be as follows: dispositions between spouses of any capital assets in the tax year of separation or in the three immediate tax years following separation (no longer living together), will not trigger a CGT liability. Also, any dispositions between spouses of capital assets that are as a result of a court-approved order will not trigger a disposal CGT purposes at any time in the future, as long as the disposal is pursuant to that order.
- Where a spouse/civil partner transfers their interest in the former matrimonial home to their ex-spouse/civil partner, receiving a percentage of the sale proceeds when the property is sold, or retains their interest but vacates the property allowing for a deferred sale, they will now be entitled to apply the same tax treatment to those proceeds (when received in the future) that would have applied at the time when they left the property or transferred their interest in the property to their ex-spouse/civil partner. That spouse/civil partner can claim the Principle Private Residence Relief (PPR) for CGT purposes (any gains are relieved from a CGT liability on the disposal of the main residence, and for a period of up to nine months immediately following the residence no longer being their main residence) as if they had remained in the property subject to them not having another PPR in the interim period.
It is worth noting on this provision that the practical application is potentially limited for those spouses who wish to move on with their lives, accommodation wise. If a new main residence is acquired by the departing spouse (i.e. a new main residence is purchased), then relief is lost under this provision and PPR would only apply to the time of occupation as PPR (and nine months following the property ceasing to be the main residence).
Potential international perspective
There are always exceptions to every rule and despite the application of the new proposed changes, international clients must remain particularly vigilant. Consideration should be given to those individuals who are dual tax resident (tax resident in more than one jurisdiction) and where recourse may be needed to any relevant double tax treaty between the jurisdictions of residence (remembering that double tax treaty relief may only apply to the extent that tax is levied in the other jurisdiction). A classic example of where care is needed is that of US citizens holding UK residential property. Despite the fact that PPR may apply to the disposal between spouses from a UK perspective, the US tax authority does not recognise a similar spousal exemption for disposals between spouses of residential property abroad. This can give rise to a gain and CGT liability in the US (indeed this is an issue not unique to spouses that are divorcing but applies generally to spousal transfers of UK residential property).
Although some separating spouses/civil partners manage to conclude financial matters arising from divorce/civil partnership dissolution prior to the end of the tax year of their separation, for many couples, such as those who separate in the March prior to the end of the tax year in April, they have very little time to finalise matters.
Therefore, the proposed changes which extend the window of ‘no gain, no loss’ transfers/disposals to three tax years after the end of the tax year of separation, or where there is a formal court order with no time limit, are very welcome and go some way to removing the issues highlighted above.
There will of course be a potential degree of overlap in the proposed relieving provisions above, in that more than one provision may be applicable. Point 3 relates purely to the family home/main residence.
Although the new provisions will still require separating spouses to take good legal/tax advice and there will still be a need in some cases for a consideration of timing, the new proposals provide a huge step forward in assisting separating spouses in parting ways in as tax efficient a manner as possible.
In all cases, CGT should be considered at an early stage of separation/divorce and advice taken at the outset as to the potential ‘best case’ scenario; this may play a tactical and practical role in negotiations and certainly to avoid a ‘dry’ CGT triggering event at a time when cash is not available (has not been generated) to pay for the same.
Some separating couples may want to consider delaying the transfer of assets until after the 5 April 2023 to take advantage of the proposed new rules.
As ever, there is the perennial reminder that long term partners who are not married or in a civil partnership will not benefit from any of the above provisions (old or new) upon any separation: there is no such thing as common law spouses for tax purposes!
For more information on the issues discussed, please contact our financial advice solicitors.