Divorce and Capital Gains Tax (Should I stay, or should I go now?)

As discussed in our Tax Bite of December 2020, it has always been a cruel outcome that divorcing couples who fail to get their affairs in order by 5 April in the tax year of separation, are subject to capital gains tax (CGT) on any later transfer of assets between them.  It is a very organised (un)couple that thinks about tax in this situation. For this reason, last year the Office of Tax Simplification recommended that the CGT rules on a divorce were relaxed. This week the government agreed. Draft legislation which is to be included in Finance Bill 2022-23 operates in respect of disposals on or after 6 April 2023.

Current rules

As a quick recap, the current CGT rules on divorce are:

• Couples who are married, or in a civil partnership, can transfer assets between themselves at ‘no gain/no loss’. When a marriage breaks down, this valuable relief ceases on 5 April in the tax year of separation. Compounding this, the transfer is deemed to be at market value, as the couple remain ‘connected’ until decree absolute, with CGT payable on any gain.

• There is an exception to the above rule, where Principal Private Residence Relief (PPR) can be extended on a transfer of a property to the spouse who continues to inhabit in the property. We discussed this in our Tax Bite in May which can be found here.

Proposed new rules

There are four proposed rule changes:

• The ‘no gain/no loss’ rule is extended until the end of the third tax year after which the couple separate. This will end earlier if the court grants an order, or decree for the divorce. For example, if A and B separate on 22 July 2022 the ‘no gain/no loss’ rule will apply to any transfers until 5 April 2026 (unless they are divorced before that date).

• The ‘no gain/no loss’ rule will apply to all assets transferred with no time limit, provided it is undertaken under a formal divorce agreement, or by order of the court. Clearly, care will be needed that those assets are transferred under the applicable mechanism to qualify for this relief.

• The current PPR exemption (see above) may not be required, as the residence can be transferred to the spouse remaining in the property under ‘no gain/no loss’ rules above. However, this rule will be extended so that it also applies on the sale of a property to a third party. Therefore, the spouse who has left the property can claim PPR as if they had remained in the property, subject to them not having another PPR. This is helpful if a ‘Mesher’ order or ‘Martin’ order is in place.

• PPR can be claimed under a deferred sale agreement or order. This is where a spouse has transferred their interest in the former matrimonial home to the spouse who remains in occupation, but they retain a lien over their share of the proceeds when that home is eventually sold. The PPR that can be claimed will be the same proportion as applied at the date of the original disposal.

Forbes Dawson view

Divorce is often an emotionally and financially difficult process, and the division of assets is not normally concluded by 5 April in the tax year of separation, particularly where large values are at stake. Therefore, the new rule changes give couples the time to finalise the divorce, without the worry of a tax sting. The rules will also allow couples who are asset-rich but cash-poor to divorce without selling assets to fund CGT liabilities. In some cases, it will be advantageous to delay the transfer of assets until after 5 April 2023 to take advantage of these new rules.

 

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