When the breakdown of a marriage occurs, the potential gains that can arise from tax planning cannot be ignored
When the breakdown of a marriage occurs, tax considerations are likely to be the last thing on the parties’ minds. However, the potential gains that can arise from tax planning cannot be ignored, especially where it can be demonstrated that both of the parties concerned may benefit.
Section 58 of Taxation of Chargeable Gains Act 1992 (TCGA92) provides that transfers of assets in a tax year, between spouses or civil partners who are ‘living together’ in any part of the year, are regarded as being made on a 'no gain/no loss' basis.
This means that the person receiving the asset is treated as if he/she has paid an amount equal to the total of its original costs.
The ‘no gain/no loss’ treatment continues to apply to transfers between spouses or civil partners throughout the whole of the year in which separation takes place, even though the spouses or civil partners may not be 'living together' at the time of transfer.
If a divorce or dissolution of a civil partnership takes place in the same tax year as separation, the ‘no gain/no loss’ treatment applies to transfers of assets made after that divorce or dissolution, but before the end of the tax year.
The definition of ‘living together’ is given in ICTA 1988/s 282. A woman is treated as 'living together' with her husband unless she is (a) separated under a court order, (b) separated by a formal deed of separation or (c) separated in such circumstances that the separation is likely to be permanent.
A couple may be separated even when they are still living in the same house (Holmes v Mitchell STC 25) - for example, because financial considerations make alternative accommodation unavailable for one spouse or civil partner, or where the parties want to minimise the initial impact of the separation on their children.
Where a transfer occurs between spouses or civil partners after the end of the tax year in which they stop ‘living together’, the rules to decide the date of disposal and the amount of consideration on disposal are as follows:
(a) Date of disposal
For transfers made as part of a divorce agreement, the date of disposal for capital gains tax purposes is the date of the agreement.
If transfers take place following a court order, the date of disposal for capital gains tax purposes is the date of the court order, unless that precedes the date of the decree absolute, in which case the date of the decree absolute is the effective date.
(b) Amount of consideration
Transactions between a husband and wife (or civil partners) after the tax year of separation cannot take place at ‘no gain/no loss’, as section 58 of TCGA 1992 is no longer applicable.
Furthermore, a husband and wife (or civil partners) are connected persons by virtue of TCGA92/s286(2). This is so even if they are permanently separated, and it remains the case until the date of the decree absolute which ends their marriage.
Section 18(2) of TCGA 92 provides that transactions between connected parties are always treated as transactions otherwise than by way of a bargain made at arm’s length.
TCGA92/s17(1)(a) provides that where a transaction takes place which is otherwise than by way of a bargain made at arm’s length, the consideration for the disposal of an asset is deemed to be equal to the market value of that asset at the date of disposal.
Accordingly, in general, the transfer of an asset between a husband and wife or between civil partners, who are permanently separated, is treated as taking place for consideration equal to the market value of the asset transferred on the date of the disposal
The market value rule can extend beyond the date of the decree absolute where a disposal is not made by way of a bargain at arm’s length. For example, a disposal under a court order would not be a bargain at arm’s length and therefore requires the substitution of market value.
After the decree absolute or dissolution, the former spouses or civil partners cease to be connected persons (unless they are connected for other reasons - for example, because they are business partners) and, accordingly, transactions between them take place at the value placed by both parties.
As the matrimonial or civil partnership home will constitute, in many instances, a significant part of a couple's wealth, it is usual for the matrimonial or civil partnership home to be sold and the proceeds split between them or, alternatively, for the interest of one spouse or civil partner in the home to be transferred to the other.
The spouse or civil partner who has moved out of the matrimonial or civil partnership home on separation may transfer his/her interest in that residence to the other spouse or civil partner, as part of the settlement. The transfer may be ordered by the court or may be voluntary.
The transfer is a disposal for capital gains tax purposes, and a gain may accrue. This would be the case if the period between moving out of the matrimonial or civil partnership home and the transfer is longer than the final 18-month exemption period.
The charge is mitigated, in appropriate cases, by an election under TCGA92/s225B, for disposals on or after 6 April 2009. For disposals made prior to 6 April 2009, Extra-statutory Concession D6 applies.
TCGA92/s225B allows the former matrimonial or civil partnership home to be treated as the only or main residence of the transferring spouse or civil partner from the date on which his or her occupation ceased until the earlier of the date of transfer and the date on which the property ceases to be the only or main residence of the spouse or civil partner to whom the property is transferred.
However, if the departing spouse or civil partner acquires another property, he/she will not obtain private residence relief (PRR) on his/her other property for the period that the matrimonial or civil partnership home is deemed to be his/her principal residence. Therefore, a cost/benefit analysis should be undertaken before deciding whether or not it is in the departing spouse's or civil partner’s interest to apply the concession.
An order by the court that a spouse or civil partner holding an interest in the matrimonial or civil partnership home should hold it on trust for a limited period - for example, until the 18th birthday of their youngest child - and entitling the other spouse or civil partner to occupy the home for the trust period, is often referred to as a Mesher order.
Where this situation occurs, the spouse or civil partner making the transfer can make a claim for TCGA 92 sS225B to apply, and so private residence relief will be due in full.
When the youngest child reaches his/her 18th birthday, there is a second occasion of charge. However, full relief is available under TCGA92/S225.
Another area of concern relates to divorce court orders governing post-divorce asset realisations.
HMRC guidance provides that if the court instructs one party to hand over a certain percentage of the proceeds on a sale of an asset to the other party, the person receiving the proceeds is not chargeable to capital gains tax on the amount received.
This is because it represents financial provision by order of the court, and is not a sum received in consideration for the disposal of an asset.
The guidance also states that the party making the payment is not entitled to a deduction for the amount paid to the other party, because the sum is an allocation of the proceeds and not a deduction in arriving at the gain.
In conclusion, no capital gains tax is payable on transfers between spouses or civil partners in a tax year in which they are living together. This includes the year in which they separate.
Where a transfer takes place after the year of separation, capital gains tax may be payable. The transfer is normally treated as being made at market value, because the spouses are still connected persons until the decree absolute.
Ideally, transfers of chargeable assets between the parties should therefore take place before the end of the tax year in which separation occurs.
Where a transfer of assets could give rise to a capital gains tax liability, making the transfer in different tax years may reduce the total bill by taking advantage of two annual exemptions.
If the transferor spouse's or civil partner’s capital gains tax rate is likely to be lower in one tax year than another, accelerating, or delaying, a transfer of assets could improve their capital gains tax position.