New Change to Capital Gains Tax Rules for Divorcing Couples

New Change to Capital Gains Tax Rules for Divorcing Couples

Back in July, the Government published draft legislation giving divorcing couples and civil partners more time to sort their financial affairs around the transfer/division of assets without incurring capital gains tax. During what most would describe as one of the most stressful times of their life (separation and divorce), you can be forgiven for not having the tax implications of divorce high up on the priority list. Unfortunately, as many have found to their cost, the current rules on the transfer of assets can have some very unwelcome side effects in terms of nasty capital gains tax surprises.

Thankfully, the Government have listened to the Office of Tax Simplification and has proposed a much longer time period for divorcing couples to sort out their financial affairs without detrimental tax effects. In reaching a financial settlement on divorce or dissolution of a civil partnership, the parties will quite often agree to a split of the assets such as the family home; other property; stocks and shares; business interests etc. So what are the tax rules to consider in such a settlement?

The Current rules 

Under the current rules, an asset can be transferred from one spouse to another free of any capital gains tax (CGT) on what is known as a “no gain / no loss” basis, unless they are “separated”. If they have instead separated, then this treatment is only available until the end of the tax year in which the separation occurred. After that, the normal CGT rules apply, which would treat the transfer of assets as taking place at “market value” and could therefore result in an unexpected tax charge on the transferor.

For example, let’s assume the husband (H) had previously purchased a Buy-to-Let property for £300,000 which, over time, increased in value to £400,000. As part of a separation/divorce settlement, H wants to transfer this to his spouse (W). If the transfer was made after the tax year in which they separated, there would be a capital gain on H of £100,000 on which CGT would be due £28,000!

If couples separate towards the end of a tax year, there is very little time to sort out any transfer of assets before CGT issues kick in.

It's not usually an issue with the matrimonial home (main residence) as Principal Private Residence (PPR) relief should be available, but even this can cause issues if a share in the house is retained by the spouse that leaves the home; until their children finish full-time education, for example.

Take the situation whereby the husband and wife own the house jointly, and it is agreed that the wife should remain in the home until the children finish their education. The divorce order states that the home should then be sold. There are no transfers at the time of the order, so capital gains tax is not a concern at that point. Let’s assume the divorce takes place when the youngest child is 15 and the husband moves out of the property. The youngest child finishes education at 21 and the property is then sold. If the husband and wife lived in the property from the point of acquisition, the wife should be able to claim principal private residence relief on her share on the sale of the property and she, therefore, has no tax liability. The husband, however, can only claim PPR relief for the period that he lived in the property and so is likely to have a capital gains tax bill based on the period for which the PPR relief does not apply. This could be substantial if the property price has risen significantly over the 6 years since he left the home!

Proposed changes

The draft Finance Bill thankfully goes some way to addressing these issues, with the following changes from the start of the 2022-23 tax year:

1. Separating spouses or civil partners will be given up to three years after the year they cease to live together in which to make no gain or no loss transfers for CGT purposes
2. No gain or no loss treatment will apply to assets that separating spouses or civil partners transfer between themselves as part of a formal divorce agreement (regardless of the time period from separation)
3. A spouse or civil partner who retains an interest in the former matrimonial home will be given an option to claim Private Residence Relief (PRR) when it is sold. This would mean that a choice will need to be made by the individual to have the PPR on the former matrimonial home or their new home – so care will still be needed here
4. Individuals who have transferred their interest in the former matrimonial home to their ex-spouse or civil partner, and are entitled to receive a percentage of the proceeds when that home is eventually sold, will be able to apply the same tax treatment to those proceeds when received that applied when they transferred their original interest in the home to their ex-spouse or civil partner

It is envisaged that these changes will provide additional relief for separating spouses and civil partners at a stressful time. These changes are welcome and should ease the time pressures on reaching financial settlements etc.

The Treasury cite the following in its impact statement for the policy proposal:

1. These measures will make the process fairer for spouses who are separating or divorcing and are distributing assets between themselves
2. These measures will especially benefit those parties involved in more complex proceedings, as it means that more time can be spent on the divorce considerations, rather than Capital Gains Tax considerations
3. The time limit extension will also help avoid further depletion of household income or existing accumulated household wealth through dry tax charges for those who meet the new time period. There will be similar benefits for those individuals who are transferring assets between themselves that are listed in a divorce or separation agreement.

However, it is still necessary to take tax advice tailored to your specific circumstances should you, unfortunately, have to go through the trauma of divorce – so please speak to your relationship partner here at Raffingers for such advice and, if you have any other questions, don't hesitate to email me at paul.dell@raffingers.co.uk or click here.