Will you be taxed for transferring your shares in the family business to your spouse as part of the divorce settlement? This article explores the options for dealing with a company shareholding in a divorce and illustrates the importance of getting the timing right.
In many divorces, it is not unusual for both parties to hold shares in a family company. Often this company involves other family members but the most common scenario is a company in which the spouses hold 50% of the shares each, this structure often having been advised by the family accountant to minimise the payment of income tax. In this situation, recent changes in guidance by HMRC highlights the importance of fully exploring the options for dealing with spouses shareholdings in a company on divorce before any separation takes place.
What are your options?
There are two main options:
#1 – Transferring shares directly from one spouse to the other as part of the divorce
The transfer of shares from one spouse to another is usually done by a court order in the divorce. Timing is vital here. As spouses, a transfer of shares from one spouse to the other will be free of Capital Gains Tax (CGT) payable at the point of transfer, if it takes place within the tax year in which the couple permanently separate. It is important to note that it is the date of separation and not the commencement or finalisation of divorce which is the tax point.
For example, if a couple separate in May and they transfer shares between them in November, there will be no CGT payable on the transfer due to this being within the tax year of the separation (this is known as the inter-spousal exemption). If, on the other hand, they separate in March and transfer shares in May, CGT will be payable as the tax year and thus the interspousal exemption ended on 5 April of the year in which they separated.
This can make a massive difference to the financial outcome and if this is not anticipated and planned for, the matrimonial finances suffer an unnecessary blow from a large tax bill, which may make the divorce settlement more difficult to finance. Until relatively recently, a couple transferring business assets such as shares outside the tax year of separation used to be able to claim Hold Over relief (officially called Gift Relief) which effectively postponed payment of the CGT to any future sale even if this transfer took place outside the tax year of separation.
HMRC have recently revised their guidance on Gift Relief to say that this will no longer usually be available to spouses after the end of the tax year of separation. This means that if, for example, a spouse transfers their shares in the family company to their other spouse outside the tax year of their separation, then they will be charged CGT on the full market value of the assets they are transferring and the tax will be payable within a short time of the transfer.
The lesson here therefore is to plan ahead. Try not to separate close to the end of the tax year if there are assets which need to be transferred – take advice first and either transfer assets within the tax year of separation, or explore other options such as remaining shareholders or buyback.
#2 – The company buys back the spouses shares
This is known as a Company Buy Back of Shares. This option is often very attractive if:
- The couple need to release cash from the company to pay the outgoing shareholder and there are few assets outside the company to offset; and/or
- The couple separated some time ago and therefore are outside the possibility of the inter-spousal CGT exemption dealt with above.
If a number of conditions are met, then the buy back of shares by the company will result in a CGT charge for the spouse transferring the shares, but CGT is only charged at 10% which is a very advantageous rate of tax and represents a far cheaper option than raising tax through dividends from the company which will be taxed at a much higher rate. This 10% relief was known as Entrepreneurs Relief (ER) but is now called Business Asset Disposal Relief (BADR).
Take advice before transferring shares as part of your divorce
Prior accountancy and legal advice should always be taken as there are a number of technical hurdles, including that the company has sufficient distributable reserves and that the transferring shareholder has been a shareholder and office holder in the company for a requisite time.
If the conditions are not met then HMRC will not give clearance for the buy back and full CGT or full income tax will be payable.
For this reason, if a buy back of shares is contemplated then the spouses should take early professional advice before taking any action about the company. For example even if the couple have been separated for a number of years, the outgoing spouse should not leave the company as an employee or office holder such as Director or Company Secretary before the buy back of shares has been completed. Otherwise the availability of BADR will be lost and full CGT payable.
In summary, the timing of the transfer or buy back of shares is vital in many ways. The most important thing for the shareholders involved in a divorce is to take early professional advice, preferably before separation but if that is not possible, promptly and before making any changes to the company structure. This is especially important if there are other shareholders involved.
At Stephens Scown, we have decades of experience in navigating clients through the options for the best possible outcome in a divorce case involving a business and the transfer of company shareholdings. Working closely with reputable accountants and business valuers we can ensure a tailor made tax efficient solution which minimises the stress and risk to both the couple and the business – vital considerations for all concerned.