Changes to Capital Gains Tax rules on divorce & dissolution make financial separation more flexible

Following the Spring Budget 2023, it has been confirmed that proposals put forward in the Autumn Statement 2022 making changes to the rules that apply to transfers of assets between spouses and civil partners who are in the process of separating will now come into force on 6 April 2023.

The new proposals provide a huge step forward in assisting separating spouses in parting ways in as tax efficient a manner as possible.

Early advice

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 amendment to the tax rules have been updated to reflect a fairer and more modern approach to separation and divorce.

As a reminder, the current (pre 6 April 2023) 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 or before 5 April 2023, they can only 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 separated on 1 September 2022 but they did not resolve financial matters until June 2023, the transfer will be deemed take place at market value as it is after the tax year of separation (2022/2023) and they will be considered connected parties for CGT until decree absolute/final order.

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.

New rules from 6 April 2023

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 also 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 2023, the ‘no gain/no loss’ rule will apply to any transfers made until 5 April 2027 (or the date of divorce if earlier).

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 position prior to 5 April 2023 limited the no gain/no loss CGT treatment to the tax year of divorce only.

The position therefore will be as follows from 6 April 2023:

• 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 (even if this is more than three tax years after the tax year that they stop living together), as long as the disposal is pursuant to that order.
• Where a spouse/civil partner retains an interest in the former matrimonial home they will be given an option, subject to certain conditions, to be able to treat the period of no longer residing in the home as if it had been their only or main residence until the time of disposal and claim private residence relief (PRR) when that interest is sold to a 3rd party.

It is worth noting that the practical application of this provision 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 then if they wish to claim relief on the former matrimonial or civil partnership home it will be lost on the new main residence.

• 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.

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).

Comments

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 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.

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.

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!

This insight was also co-produced by Partner, Haydn Rogan, haydn.rogan@weightmans.com.