A common concern amongst married couples who are separating is the potential capital gains tax (“CGT”) liability which may arise upon transfer of the family home and other assets following separation.
Current tax rules
Married couples and civil partners may transfer assets between them on a “no gain, no loss” basis, meaning no CGT liability will arise on the transfer of an asset from one spouse to another. Instead, the gain is effectively rolled over to the transferee spouse, to be realised at a later date.
Under the current rules, separating couples only have a narrow window of time in which to transfer assets between them on the “no gain, no loss” basis which married couples enjoy. For this basis to apply, separating couples must transfer any assets from one to the other within the tax year of separation. This means that if a couple separate in January 2022, they only have a few months, until 5 April 2022, to execute the transfer of an asset without incurring a potential CGT liability.
Where there is only a small chargeable gain, this is often covered by the CGT annual exemption. However, with the CGT annual exemption set to be substantially reduced over the next three years from £12,000 at present to £6,000 from April 2023 and then to £3,000 from April 2024 absent any changes to the tax rules we are likely to see CGT becoming ever more an issue for separating couples.
Family home
Where there is to be transfer of a share in the family home, as frequently occurs upon a separation, the spouse transferring their share will generally see the gain on that share covered by the principal private residence (“PPR”) relief, so long as the transfer takes place within nine months of the end of the tax year of separation (as PPR relief continues to apply for nine months following the spouse leaving the family home).
However, issues may arise where the transferring spouse has vacated the home and PPR relief no longer applies in full (for example, where they have purchased a new property and more than nine months have passed since they vacated the family home).
Often forgotten, there is further relief available to cover the scenario where the leaving spouse transfers their share of the jointly owned property to the remaining spouse more than nine months after leaving the family home. This relief is available subject to a number of conditions, namely that (i) the property is transferred to the remaining spouse as part of a financial settlement, (ii) the vacating spouse has not elected a new principal private residence, and (iii) the property has remained the main residence of the remaining spouse.
Impact on separating couples
Where the chargeable gain is substantial and the tax liability is required to be paid within 60 days of the disposal of the interest (as is the case for disposal of the family home), this raises a number of issues:
First, how is the transferring spouse going to find the cash pay the tax due?
Second, should the transferring spouse be required to make any elections that might be possible to mitigate their CGT liability (thereby potentially leading to a CGT liability on the sale of another property they own in the future)?
Third, how should that tax liability be factored into the financial settlement, if at all?
As professionals and those going through the process know only too well, it can take many months, if not years, to conclude a financial agreement. In an effort to avoid this tax leakage, couples may choose either to delay the separation process or to rush through financial negotiations, but with the risk in either case of unwelcome consequences which could be avoided.
Government proposals
Helpfully, the government looks likely to adopt proposals to address these issues (set out in the policy paper published on 20 July 2022 in the Finance Bill 2022-23, which is currently in draft form. The main change will be to extend the “no gain, no loss” window for separating couples to the earlier of (as drafted at the date of writing):
The last day of the third year after the year in which the parties cease to cohabit; and
The day on which the final order for divorce is granted, or the marriage is annulled.
Or, even more helpfully, where the disposal of the asset is in accordance with an agreement or order, then the window is extended indefinitely.
If the legislation is passed, separating couples may benefit from the new rules as soon as 6 April 2023.
The government proposals also include extending the scope of PPR relief for the spouse who has left the family home prior to sale of the home but who retains a financial interest in the property (covering deferred orders for sale, for example). This should simplify matters for divorcing couples who are looking to transfer the home into a sole name.
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These changes, if implemented, as it appears they will be, will be welcomed by couples and their advisors alike. It will also make CGT liability more consistent with related tax liabilities such as Stamp Duty Land Tax (“SDLT”), which given that, for example, is already not payable on the transfer of an interest in a property to a spouse when the subject of a court order.
This extension of the “no gain, no loss” window will allow couples to focus on other parts of the financial negotiations without having to worry about CGT, and will help prevent depletion of the funds available for distribution.
There are still a number of other tax issues relevant to separating couples which warrant the Government’s attention but which these proposals do not cover, such as the treatment of assets overseas and the tax liability arising on the transfer of such assets, as well as the tax payable on the withdrawal of capital from a family business to fund a lump sum payment upon separation. However, the current proposals are a positive indication that the Government is taking these tax issues seriously, and, if enacted, will be to the benefit of many separating couples.
Query what constitutes separation for these purposes. Most family lawyers take the issue of divorce proceedings as definitive in this scenario.