While you may be tempted to wait for no fault divorce to start in April, choosing to delay your divorce may actually cause significant (and expensive) problems with Capital Gains Tax (CGT).
With the inception of no fault divorce on 6 April 2022, many already separated couples or those contemplating separation may be tempted to delay their divorce. Whilst this may be for the best of reasons, such as wishing to avoid any further acrimony, the decision to delay may in fact cause further significant and unforeseen tax problems.
No fault divorce and CGT
The basic rule for married people is that they can transfer assets between them without incurring a CGT liability. This changes when people separate.
Once a couple have separated they lose the “inter-spousal” exemption for CGT on transfers at the end of the tax year in which they separate. After that time tax is payable usually at 28% on any transfers. Clearly if a couple have a portfolio of property or other capital assets which they have owned for some time, then a CGT bill on transferring the properties into their respective names can result in huge unnecessary CGT bills.
In the current situation, if a couple separate now, but delay their divorce and the resolution of financial matters to take advantage of the new no fault divorce after the 6 April, they will have lost the inter-spousal exemption and CGT will be fully payable as if they were not married.
It is often a surprise to people that CGT liability is governed by the separation date rather than the date that the divorce itself is issued and people often separate without thought to the tax consequences which can be severe. If contemplating separation in the next few months, it is therefore critical to take specialist legal advice before actually separating.
How to approach the situation
If you’ve already separated:
There are options which can be considered if separation has already taken place.
It is possible to negotiate a swift and tax efficient solution before the end of the tax year, but if this proves impossible, then with the correct tax advice transfers between the couple can be made on a “without prejudice” or interim basis to avoid the worst of the CGT liabilities.
If you’ve not separated yet:
If separation has not yet taken place it may be sensible to consider delaying separation as well as divorce during the final couple of months of the tax year.
If, for example, a couple separate in May, then they have the whole of the next tax year until the following April in which to negotiate a sensible financial settlement and avoid any unnecessary tax charges.
CGT rules for property
There are different CGT rules that apply to the family home which is usually free of CGT on sale or transfer. This position again changes with separation.
If one of the spouses moves out then they begin to incur a CGT liability on their share of the family home nine months after they first moved out. In reality, many divorce settlements take longer than this to resolve so if a couple separate without legal advice and then delay divorce proceedings (perhaps with an eye to the no fault legislation) they may have a very short window of time before a CGT liability begins to arise.
It is important to emphasise that the current system of divorce, where couples have to establish either grounds of adultery or unreasonable behaviour unless they have been apart for two years, certainly does not have to result in acrimony.
Very often it is possible to agree the contents of the petition amicably to enable an immediate divorce to proceed and thus tackle property and tax issues urgently to avoid liabilities. The most important factor is to be aware of possible tax charges in making decisions – take legal and accountancy advice early before separation, however informal the separation feels to you.
The definition of separation is a complex matter but a couple certainly do not have to be legally separated by a Deed or Judicial Separation to be deemed to be separated by the Revenue.
As Princess Diana famously said, “there were three of us in this marriage”. Whilst she was referring to Camilla, the analogy can be similarly used in that the separating couple are joined by the looming presence of the Inland Revenue and therefore care must be taken to make sure that the difficult issue of divorce and separation isn’t made worse by an unexpected tax bill.
If you would like advice on any of these issues, please get in touch.