Changes to Capital Gains Tax on divorce

The government recently announced plans to relax the Capital Gains Tax (CGT) rules within divorce financial settlements. They have published a policy paper that stands to significantly improve the treatment of Capital Gains Tax for spouses and civil partners who are in the process of separating.

HMRC stated that they ‘hope this will give spouses and civil partners more time to transfer assets without incurring a charge to CGT’.

What are the existing Capital Gains Tax rules?

At present, when a married couple or civil partners separate, they have until the end of the tax year in which they separate to transfer chargeable assets between them free of CGT. This is known as ‘no gain no loss’. If the transfer takes place in the tax year after their separation, then the transfer is deemed to be at market value and CGT is payable based on the gain at transfer.

Chargeable assets are any assets that attract a charge to CGT, such as property, shares, business assets and some personal possessions, amongst other things. Transferring those assets prior to the tax year end in which the couple separate can often save significant amounts in tax.

What is the issue with the existing Capital Gains Tax framework?

The issue, for many, is that this tax bill comes at a time when cash funds may be low and where a separated spouse may be keen to ensure their future financial security following a divorce. Those who have left the family home (and are not present there for more than nine months) are penalised under the current rules as they are deemed to no longer benefit from full main home Private Residence Relief (PRR) when it is sold.

The existing rules also present major problems for many couples separating towards the end of a tax year (i.e. immediately prior to 5 April), and those who had separated earlier in the tax year but didn’t know about the tax savings that could have been made from transferring assets earlier. Steps can be taken to mitigate tax if sufficient time is left prior to the tax year end, however it does require the couple’s agreement. Unintended tax consequences can arise solely as a result of the date a couple decide to separate. It can be significantly expensive for the couple and reduce the number of settlement options available to them.

What are the new changes proposed?

The proposed changes will mean that:

• Separating spouses or civil partners will be given up to three years after the year they cease to live together to make no gain or no loss transfers.
• No gain or no loss treatment will also apply to assets that separating spouses or civil partners transfer between themselves as part of a formal divorce agreement.
• 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, providing that the sale and absence from the property is due to divorce.
• 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.

The changes will not impact any assets that are sold as part of proceedings. The Capital Gains Tax position on sale will remain the same (CGT payable within 60 days of sale). It is also unclear at present whether the changes will apply retrospectively to say those separating now.

When are the changes due to come in?

If approved, the new rules are proposed to apply to disposals on or after April 2023. Whilst these are only proposals at this stage, all commentary would suggest that the changes are significantly likely to be made within the Finance Bill 2022-23 and will be welcomed by many.

What should you be thinking about now if you separated prior to 5 April this year?

Married couples or civil partners who separated prior to 5 April this year and have assets that will need to be transferred between themselves (either joint assets to either party or solely owned assets to the non-owning spouse) might consider deferring those transfers until after the end of the current tax year, in the hope that the proposals outlined in the policy paper become law.

If these couples have already agreed a settlement and are drawing up their Consent Order now, they need to take care to ensure that the mechanism included in the order for transferring assets between them is tax efficient and pays adequate regard to the potential changes. It is quite possible that deferring the transfers until the next tax year could, under these proposals, save what might otherwise be a significant capital gains tax charge.

What should you be thinking about if you separated or are planning to separate in the current tax year?

Married couples or civil partners who may have separated or are planning to separate in the current tax year may have the certainty of the existing no gain/no loss rules and until 5 April 2023 to transfer assets between themselves free of any CGT charge. Until the proposals are confirmed as law, it may still be sensible to rely on the current window.

For further information or advice regarding Capital Gains Tax on divorce, please contact our Family Law team on 01305 771000.