Why do I need to worry about tax on divorce?
There are special tax rules and exemptions for spouses and civil partners which predominantly apply for capital gains tax (“CGT”) and inheritance tax (“IHT”). For CGT, these rules allow assets to pass between couples at no gain / no loss for tax purposes. This means that the inherent gain in an asset is transferred to the other spouse and will only be triggered if they “dispose” of the asset. As divorce is the process of legally separating, you must consider the impact of the withdrawal of these reliefs and what this means for your current or future tax liability.
When jointly held assets are divided between divorcing couples, the tax reliefs which were previously enjoyed between spouses may not now be available. Furthermore, generating a “dry” tax charge where there are no cash proceeds to pay the tax is clearly a problem. There is additional complexity given a change in the rules for the transfer of assets from the 6 April 2023.
As divorce settlements, particularly for clients with multiple martial assets, can take significant time to complete, it is important to understand the time limits and procedures which need to be adhered to, in order to mitigate CGT.
Pre 06 April 2023 rules
Before the changes, the rules for divorcing couples were stringent. Chargeable assets could only pass tax neutrally between spouses or civil partners who were living together during any part of the tax year in which the disposal occurred. If the transfers did not take place quickly, it was easy for separating couples to lose out on the beneficial tax treatment. Hence the closer to the end of the tax year that the permanent separation occurred, the lesser the time available to negotiate agreement which might work for tax.
Post 06 April 2023 rules
Following recommendations from the Office of Tax Simplification, the government approved rules to allow those going through a divorce more time to sort out their affairs.
The new rules state that the beneficial no gain/no loss treatment will apply:
To the transfer of assets between those who have ceased to live together made on or before the end of the third tax year following the tax year of separation or the date of the divorce, dissolution or annulment of their marriage or civil partnership if earlier.
To disposals between couples that have ceased to be, or are in the process of ceasing to be, married to or civil partners of each other and the disposal is in accordance with:
an agreement made between the individual and their spouse or former spouse in contemplation or connection with the dissolution of the marriage or
an order of a court either granting an order or decree of divorce or nullity of marriage, or for judicial separation.
These rules increase the period that separating couples have to deal with the emotional and practical consequences of the relationship breakdown and to implement any agreement as to the sharing of assets, potentially, without jeopardising their entitlement to relief.
The new rules have also revised the Principle Private Residence relief rules for disposals of the marital home. Under the new provisions, the transfer of a share in the matrimonial home to the residing spouse would likely now be tax neutral.