Divorce can have a significant impact on your tax status.
Married couples and civil partners receive several tax benefits, for example, transfers of assets between spouses are effectively exempt from CGT. This continues whilst the couple is living together (unless separated by court order/deed of separation). Transfers of value between spouses are also exempt from inheritance tax (IHT), as are legacies to spouses from the death estate.
For income tax purposes, there is a married couples allowance (MCA), which can reduce their income tax by between £322 and £835 a year. Married couples can also transfer 10% of their unused personal allowance to their spouse if their spouse is a basic rate taxpayer.
Please note that references to “Marriage” includes Civil Partnerships, and references to “Divorce” include annulment of marriage and dissolution or annulment of civil partnerships.
There are 2 trigger points in divorce proceedings that have significant tax implications:
The CGT relief for transfers between spouses continues until the end of the tax year (5 April) in which permanent separation (or court order/deed of separation) occurs. From a tax perspective, this makes 6 April the best day to separate, as it gives the full tax year to transfer assets and still obtain relief from CGT. An initial transfer of assets in anticipation of separation should be considered.
The couple remains legally married until the date of divorce (Decree Absolute). Until this date, the couple is “connected persons” for CGT purposes. This means that once the tax year of separation has passed, transfers are deemed to be made at market value for the purposes of calculating the CGT due on a transfer, rather than any amount actually paid for the assets.
The income tax MCA also continues until the end of the tax year of permanent separation.
Once the Decree Absolute has been pronounced the couple are no longer connected for CGT. Transfers between the individuals are treated as for transfers to any other unconnected person unless the transfer is made under a court order in respect of the divorce.
The IHT exemption for transfers of value between spouses also ends when the Decree Absolute is pronounced. However, transfers made on divorce (or subsequent variation of such transfers), or for the maintenance of the family, are still exempt from IHT after the Decree Absolute has been pronounced.
The transfer of personal allowance continues until the end of the tax year in which the Decree Absolute is pronounced, as long as the transfer has been claimed before the pronouncement.
It should be noted that the Decree Nisi has no tax implications as this is merely a document that states that the court does not see any reason why the couple cannot divorce; it does not actually change the relationship between the couple.
Other Tax Reliefs
There are certain assets that are likely to be the subject of a divorce settlement for which there may be CGT reliefs available:
Family Home: There is an extension to Principle Private Residence (PPR) relief for disposals in connection with a divorce: Where on party to the marriage has moved out, and has not formally elected with HMRC for another house to be their main home, the other party continues to live in the family home as their main house, and the spouse moving out then transfers their share of the property as part of a divorce agreement, the family home is treated as being their only or main home until the date of disposal.
Depending on the likely gain arising on the property being moved into (if purchased) this extension of PPR relief may or may not be of benefit. Advice should be sought as to whether this extension should be achieved, or avoided through a formal election with HMRC.
There is an exemption from SDLT for transfers between spouses as part of an agreement or court order in respect of divorce. A land transaction return will still be required in order to claim this relief.
Businesses: There is often a family business that is wholly or partly transferred, as part of a divorce settlement. The transfer of sole trader businesses, interests in partnerships that are trading and certain shares in unquoted trading companies can have any gain arising on the transfer held over until the recipient sells the asset.
Clearly, this will only be advantageous after the tax year of permanent separation (and therefore the possibility of CGT exempt transfers) has ended. Advice should be sought if planning to use this relief as the requirements for qualification are complex.
It should be noted that this does not exempt the gain on the transfer, but merely postpones the gain from coming into the charge to CGT until the business is disposed of by the recipient, thus the spouse disposing of the business is passing over their gain to be taxed in future on the recipient, hence the requirement for a joint agreement.
A separation and divorce is a difficult time for all parties involved and the last thing anyone wants is a nasty tax surprise as part of the process. Tax Innovations can help to ensure that the process of separation is managed in a tax efficient manner and that all parties are aware of the tax consequences of any agreement.