Divorce can be painful for all kinds of reasons. An added source of difficulty in reaching settlements can be capital gains tax.
What happens in terms of capital gains tax upon divorce? The UK government has been urged to hike CGT (this tax is likely to go up in the US). Couples who have amassed wealth have to confront the tax angle if they break up.
To discuss these issues are Jo Carr-West, partner and Lara Barton, partner, at Hunters Law. The editors of this news service are pleased to share these views and invite responses. The usual editorial disclaimers apply. Email firstname.lastname@example.org and email@example.com
When separating spouses are negotiating how to divide their assets, they may overlook the tax consequences of the asset transfers needed to achieve the proposed division. For wealthier couples the tax implications can be significant, with aspects of the capital gains tax system posing particular challenges. A new report from the Office of Tax Simplification has made proposals addressing two such issues.
The first relates to the CGT exemption benefitting married couples which allows them to transfer assets to each other at “no gain no loss,” i.e. without triggering a CGT charge at that time (the base cost of the asset is inherited by the receiving spouse, meaning that the full amount of CGT will be payable when they sell or transfer the asset). The “no gain no loss” rule applies during the marriage and until the end of the tax year of their permanent separation. Permanent separation occurs when the parties start living separately in circumstances that are likely to be permanent, enter a deed of separation, or are separated under a court order.
After the tax year of separation, transfers between separated spouses take place at deemed market value, meaning that even if no cash has changed hands, the transferor will be treated as having sold or transferred the asset for its current market value and will be assessed for tax on the gain. This would apply, for example, where a shareholding or holiday home is transferred from joint names into one party’s sole name.
By setting the timeframe for the end of the “no gain no loss” exemption by reference to the tax year, the system arbitrarily favours those who separate early in the tax year - spouses separating in late March have only days to benefit from the ”no gain no loss” rules, nowhere near long enough to agree and implement a financial divorce settlement.
Even those separating earlier in the tax year may struggle with the timeframe; most separating spouses do not start negotiating their divorce settlement the moment they separate. Even once the process has begun, the mutual financial disclosure, negotiations, and settlement is likely to take many months, and approval of the settlement by the court some further weeks. For those couples who need a court decision to resolve their financial arrangements, the process is most unlikely to be concluded within a year, particularly given the delays in the court system.
The current rules therefore often add to a couple’s stress in what is likely to be a very fraught time. One or both parties may feel pressurised into making decisions outside the scope of an overall agreement in order to benefit from the “no gain no loss” rule, before they have had time to fully consider all the other implications.
It is therefore welcome that the OTS recommends that:
"The government should extend the ‘no gain no loss’ window on
separation to the later of:
• the end of the tax year at least two years after the separation event; and
• any reasonable time set for the transfer of assets in accordance with a financial agreement approved by a court or equivalent processes in Scotland." (1)
This would ensure that, where a settlement is approved by a court (as is always recommended), and the transfers take place within the agreed timeframe, no immediate charges to CGT should arise. It is to be hoped that this proposal will be adopted.
The second proposal relevant to divorcing couples is of more general application, but likely to be of particular significance for separating spouses. In April 2020, HMRC drastically reduced the period for reporting and paying CGT where tax is due following the disposal of UK residential property by UK-resident individuals, trustees or personal representatives. Prior to 6 April 2020, taxpayers were required to report such disposals and pay any tax due by 31 January following the end of the tax year in which the disposal took place, giving them between nine and almost 22 months, depending on when the disposal took place. As from 6 April 2020, the timeframe is now just thirty days from completion.
This is likely to be particularly problematic for divorcing spouses. Whilst the gain on the family home will often be covered by Principal Private Residence relief, the transfer between them of an investment property or holiday home is now (if outside the tax year of separation) subject to an immediate charge to CGT. As the property is not being sold, no liquidity is being released. When the parties had many months to raise the necessary funds this could often be managed; for many it is now considerably more challenging.
Even beyond the liquidity issue, 30 days is very a tight deadline, particularly when one considers the process required to use the UK Property tax return system, which involves first creating a Government Gateway user ID (if the taxpayer does not already have one), and then setting up a UK property account, before authorising an agent to deal with HMRC on the taxpayer’s behalf (where applicable). Further, a considerable amount of information is required to calculate the CGT and complete the return, including: the base cost of the property; the cost of any capital improvements; costs of acquisition and disposal; the extent to which PPR applies to any part of the gain; details of any capital losses or available Annual Exempt Amount to offset against the gain; and an estimate of the taxpayer’s income for the relevant tax year to ascertain the rate of CGT which is likely to apply. Whilst information gathering can begin in advance, this remains a lot of information to collate, and some of it may not be readily available. For those managing the implementation of a divorce settlement at the same time, this creates additional pressure.
Given how ambitious the 30-day deadline is, it is perhaps unsurprising that research has shown that one third of the tax returns received between 6 April 2020 to 6 January 2021 took longer than thirty days to arrive. (2) (However, for returns due up until 30 June 2020, the reporting deadline was extended to 31 July 2020, making it likely that some of the so called ‘late’ returns would have been filed within the 30 days but for the extension).
The OTS recommends that: “The government should consider extending the reporting and payment deadline for the UK Property tax return to 60 days, or mandate estate agents or conveyancers to distribute HMRC provided information to clients about these requirements.” (3) Whilst the wider dissemination of information is important, it would not address the liquidity issue faced by separating spouses; the proposed extension to 60 days may be of some - limited - assistance.
Overall, the proposals of the OTS outlined in this article would assist divorcing couples. Whilst a 30-day extension to the CGT deadline in residential property transactions may be of only limited help, if the proposals to significantly extend the use of the “no gain no loss” rule are adopted, CGT would, in any event, rarely be payable on the transfer of a residential property between separating spouses.
1, Recommendation 7 in Capital_Gains_Tax_stage_2_report_-_May_2021.pdf (publishing.service.gov.uk)
2, HMRC data included within Annex D of Capital_Gains_Tax_stage_2_report_-_May_2021.pdf (publishing.service.gov.uk) [Accessed 14 June 2021]
3, Recommendation 3 in Capital_Gains_Tax_stage_2_report_-_May_2021.pdf (publishing.service.gov.uk)