Tax

How New UK Capital Gains Tax Rules Could Affect Divorce Settlements

Michael Duffy and Katie Male 10 October 2022

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New legislation will, if enacted, affect the financial settlements for divorce and, in particular, how capital gains tax is treated.

As readers know well, the UK government has been making all kinds of waves with tax changes in the past two weeks, most obviously the U-turn on scrapping the top 45 per cent income tax band. Draft finance legislation – if approved – will have several effects, including on divorcing couples. This article, from law firm Boodle Hatfield, examines what the effects could be. The authors are Michael Duffy, private client and tax associate, and Katie Male, family associate.

The editors at this news service are pleased to share these views and invite replies. The usual editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com

The draft Finance Bill 2022-23 (if approved by the new Government) contains welcome news for divorcing couples who are considering transferring assets as part of their financial settlement.

The current law provides that transfers between spouses who are living together are made on a "no gain, no loss basis" for capital gains tax (CGT) purposes, i.e. there is no CGT at the date of transfer. Instead the spouse to whom the assets are being transferred inherits the base cost of the spouse who is transferring the assets and defers the crystallisation of the CGT liability until the asset is sold or otherwise disposed. Where they separate, the "no gain, no loss" basis continues to apply until the end of the tax year in which they separate. For example, if a married couple separated on 1 January 2022, an asset transfer must have completed by 5 April 2022 to take advantage of the "no gain, no loss" principle. 

If, by contrast, the transfer took place on 6 April 2022, the transfer would be deemed to have taken place at market value. That can present real difficulties where the asset is pregnant with a significant capital gain and the parties' liquid resources are limited, as the person transferring can find themselves with a large tax bill but no proceeds of disposal with which to pay it.

Note, that the test is separation rather than divorce. For these purposes, a couple separates where either (a) there is formal separation deed; (b) there has been a separation order by the court; or (c) they are in fact separated in circumstances in which the separation is likely to be permanent. The last of these is by far the most common, although it may not be clear cut exactly when it takes place. 

It is clearly unsatisfactory that, under the current law, a couple separating on 6 April would have a far greater prospect of completing any asset transfers within the tax year of separation and thus taking advantage of the "no gain, no loss" window than a couple separating on 4 April. That said, even the couple separating on 6 April may struggle to finalise any financial settlement within 12 months, particularly if, for example, their financial affairs are complex and expert evidence in relation to valuation and tax is required, or indeed if they are unable to reach a settlement and therefore must proceed to a final hearing for the court to determine their financial claims against one another. In practice, the application of "no gain, no loss" is very rarely encountered.   

The main change under the draft Finance Bill 2022-23 is to extend the "no gain, no loss" window to the end of the third tax year after separation or such other date as may be ordered by the court as part of a formal divorce agreement.  Many more divorcing couples will therefore be able to take advantage of the deferral of the CGT liability, meaning that the immediate needs of the parties and any minor children can be prioritised.  In cases where there is a lack of liquidity, the legislative change could enable a party to retain an asset which might otherwise have had to be sold.

The new rules will apply to disposals which take place on or after 6 April 2023. Depending on the precise circumstances, the date of disposal could be the date of the transfer, the date of the court order recording the divorce settlement or the date of a Decree Absolute/Final Order. There may be some ongoing divorces where parties are able to arrange matters in such a way that any relevant disposal occurs on or after 6 April 2023; however, in many ongoing cases there will be competing drivers which call for an earlier disposal date. 

Another useful change in the draft Finance Bill relates to deferred sales of the family home. It is not uncommon for a spouse to be ordered to transfer their share (or part of it) in the family home to their spouse, for the recipient spouse to live in it until a certain date when the property is to be sold and the proceeds split. 

The transferring spouse may be eligible for principal private residence relief on the initial transfer but will still incur a CGT charge when the property is sold (possibly years later, with significant gain). The draft Finance Bill allows for the transferor spouse to claim relief on the later disposal if (s)he was eligible for relief on the initial transfer to their ex-spouse.

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