Navigating taxes during divorce and separation

With the start of a new tax year on 6 April 2024, it‘s an opportune moment to recap some key tax considerations that arise on divorce and separation.  As with all our content, when referring to divorce we also intend to cover the equivalent situation on dissolution of a civil partnership (where the tax considerations are identical) and, likewise, when referring to married couples we intend to include those in a civil partnership.

Capital Gains Tax

In simple terms, capital gains tax (called ‘CGT’) arises when a capital asset is disposed of (either sold or transferred) and that asset has increased in value during the period of ownership.  Even where an asset is given away for free, CGT will usually still arise (with that gain being based on the market value) which creates a ‘dry tax charge’ – i.e. money owing to the Revenue but with no sale proceeds from which to pay it. 

During a marriage, assets can be transferred between spouses on a ‘no gain; no loss’ basis such that (a) no immediate liability to capital gains tax arises but (b) when the recipient later disposes of the asset, they are treated as having owned it throughout the entire period of ownership (and having ‘inherited’ their spouse’s base cost). 

Until recently, the ‘no gain; no loss’ principle was only available to separated couples in the tax year of their separation; transfers between them after this date would trigger a Capital Gains Tax liability on any gains.  This often led to a quick ‘scramble’ to put in place interim transfers of assets (say, rental properties or shares in a business) in the early stages of separation (particularly for couples separating shortly before 5 April), putting unnecessary pressure on all involved and involving difficult decisions as to whether the tax benefits outweighed other commercial or tactical considerations.

Fortunately, the relief was extended with effect from 6 April 2023.  As such, transfers between spouses will take effect on a ‘no gain no loss basis’ provided:

• They take place pursuant to a formal agreement or court order dealing with the financial settlement; or
• They take place within 3 tax years of the end of the tax year of separation (or, if earlier, on or before the date the Court orders decree absolute or judicial separation).

Does this mean the Capital Gains Tax can be ignored?

Capital Gains Tax does, however, remain a very much ‘live issue’ in negotiating financial settlements given:

• if an asset is going to be sold to a third party (perhaps to generate cash to pay a financial settlement) then, absent other reliefs, Capital Gains Tax will be payable.  It will be vital that such tax is taken into account when calculating the assets available for distribution and reaching a view as to what constitutes a fair settlement.  Furthermore, deadlines for reporting and paying tax arising out of the sale of residential property are short (60 days) so accountancy advice should be sought at an early stage; and
• even if an asset is going to be retained by one of the parties, the ‘notional’ Capital Gains Tax that would arise on a future disposal (based on the valuation adopted for negotiations purposes) is usually taken into account when assessing the assets available for distribution. The family court usually takes the view that, ultimately, an asset is only worth what it would realise on eventual sale.  Detailed tax advice is therefore often required to calculate the ‘latent’ CGT within a couple’s asset base.

What about the family home?

Different considerations apply to the couple’s home.

Principal Private Residence relief (called ‘PPR’) means that, for most people, no Capital Gains Tax is payable when they dispose of their main residence. Advice should always be sought, though, to ensure the qualifying conditions are met, particularly where a property sits in considerable grounds, has areas used for other purposes, or where a couple own multiple properties.

Again, historically, difficulties arose on separation as PPR ceased being available to the spouse who moved out of the family home, causing an imbalance in the parties’ tax status and (in the authors’ view) unnecessary complications.  This was again remedied with effect from 6 April 2023 such that now:

• the departing spouse has the option to claim PPR on their former home on a future sale where they have retained an interest in it and their spouse (or former spouse) has remained living there. The departing spouse will need advice as to whether to make this claim – particularly if they have bought a new home in the meantime, as a person can only have one PPR property at any time; and
• where the departing spouse transfers their interest but remains entitled to a share of the proceeds on an eventual sale by the remaining spouse, they will be able to apply the same tax treatment to those proceeds as applied to the original transfer of their interest (i.e. if the original transfer qualified for PPR, that would apply again). 

And what about income tax?

Finally, a word on income tax. Unlike in some countries, maintenance in England and Wales (or alimony as it is called in some other jurisdictions) is paid out of taxed income, regardless of whether it is for a spouse or child’s benefit.  The maintenance receipts are tax free in the recipient’s hands.  On occasions there may be opportunities to transfer income producing assets to a recipient (such as company shares from which dividend income is received) rather than have all the income taxed in the hands of the paying spouse, therefore taking advantage of both parties’ personal allowances and lower rate tax bands. 

These considerations are complex and require a careful ‘weighing up’ of various factors.  Here at Mills & Reeve we are well placed, utilising the wealth of experience in our private client team alongside our family law specialists, to advise on the options available.