Tax Implications of Separation and Divorce

When a marriage or civil partnership breaks down the last thing on your mind is the effect that the break-up might have on your relationship with the tax man. Although, there have been recent relaxations to the tax rules, separating couples who do not factor in tax at the outset, could be in for a nasty surprise.

There are a number of considerations that you should discuss with your family law adviser, who can, in turn, refer you to a tax specialist:

1. Transferring assets between separating spouses

Capital Gains Tax (CGT) is payable when you make a profit or gain on an asset you sell or give away over and above your tax-free exemption. However, CGT does not apply on transfers between spouses or civil partners,  with assets transferring on a no gain no loss basis.

Prior to 6 April 2023 this treatment continued up to the end of the tax year in which separation took place. This could have potentially prejudiced couples separating towards the end of a tax year and then having no time to benefit from this attractive tax treatment.

Recognising that it may take much longer for separating couples to reach agreement on the split of assets a more favourable tax treatment applies to disposals on or after 6 April 2023. From that date you have up to the earlier of 3 years after the year of separation and divorce to make no gain no loss transfers of assets. There is unlimited time to make no gain no loss transfers if the assets are transferred under a formal divorce agreement.

Example

Ken and Barbie separated on 1 February 2021 and divorced during 2022/23. As part of the financial settlement Barbie transferred shares to Ken. To transfer the shares on a no gain no loss basis any transfer would have had to take place before 6 April 2021. Barbie will therefore be deemed to transfer the shares to Ken at market value and will pay CGT on any gain.

If Ken and Barbie had delayed their divorce and Barbie had transferred the shares after 5 April 2023 the shares would transfer on a no gain no loss basis and Barbie would have no CGT to pay.

2. Transfer or sale of the family home

Tax relief applies where the family home is your Principal Private Residence (PPR) so that there may be no CGT payable on any gain. From 6 April 2023, should you  move out of the matrimonial home but retain an interest in the property, you can claim PPR relief on a subsequent sale of the property provided your spouse had continued to live in the home as their main residence. Relief can only be claimed if another property has not been elected as your PPR.

Should you transfer your interest in the matrimonial home to your ex-spouse under an agreement or court order but retain the right to a share of the proceeds when the house is eventually sold,  the receipt is treated as if it had arisen under the original disposal (for example if you had a claim for PPR relief on the original disposal.

3. Acquiring a new home

Should you move out of the matrimonial home but continue to retain an interest in the family home you may be liable to pay Additional Dwelling Supplement (ADS) on the purchase of a new home in Scotland. ADS, which is charged at the rate of 6% of the purchase price is charged where the purchaser will hold an interest in two or more dwellings as a result of the purchase. A claim for repayment of ADS may be made but  would currently require you to dispose of your interest in the matrimonial home and satisfy additional conditions. . The tax cost of purchasing a new property should be taken into account before making an offer.

4. Family businesses

The extension of the tax exemption for transfers between spouses to the 3 years following separation or unlimited time where transferred under an Agreement or order of the court makes it considerably easier to transfer  assets held within a family partnership or shares in a family company without crystallising a tax charge. It removes the previous difficulty of establishing whether “hold-over relief” is available to defer the tax charge that would otherwise arise on the transfer of a partnership asset or company shares after the tax year of separation.

It does mean however that the extension of the no gain no loss provisions reduces the possibility of the transferor benefitting from any CGT reliefs such as Business Asset Disposal Relief on the transfer to the other spouse. The recipient will acquire the asset at original acquisition cost (rather than market value) and may realise a significant tax charge should they later sell it.

If a partnership operates between a husband and wife who separate, it is not unusual that the partnership will be dissolved or will continue in the name of one spouse only, sometimes with a new partner.  This could lead to tax issues depending on how the underlying partnership assets are held.  Where funds are to be withdrawn from a capital account, income tax will be payable on the profits taxable in the year of cessation of the partnership.

5. Tax exemptions on death of separating spouses

As well as losing the exemption for CGT on separation, spouses will also lose their exemption on inheritance tax (IHT) charges which would not apply when they were married.  The IHT exemption will only apply up to the date of divorce.  Transfers between spouses will continue to be exempt from a charge to IHT where the transfers are not intended to be made in return for something or where the transfer is made for maintenance of the family.

6. Income tax and tax credits

Separating spouses have a duty to support one another financially by paying aliment until they are divorced.  Sometimes payment of Periodical Allowance continue after divorce where it is ordered by the court or as part of an agreement.  The spouse making the payment of aliment from income will be taxed on their gross income. .  Maintenance payments received are not subject to income tax by the spouse receiving the payment. Tax credits for children should be claimed by the spouse with whom the children live.  This can be unclear where there is a shared care arrangement between parents.  However, as the test for tax credits is now means tested, it is expected that it is the spouse who would qualify for the credits that would claim where the children are living with each parent on a shared basis.

To avoid a situation where the tax issues on separation or divorce become taxing, or are overlooked, it is always worthwhile seeking sound advice from a family law solicitor who can direct you to the appropriate tax expert. The changes to the tax rules from 6 April 2023 also highlights the importance of couples to ensure that any earlier tax advice  they are relying upon is reconsidered and, if appropriate, updated to take these changes into account  Where there is a family business some careful consideration should be given as to how the business will be maintained in the future and plans made accordingly bearing in mind the tax consequences.

For specialist tax advice, please contact Martin Campbell or Alison Pryde, or speak to your usual Anderson Strathern contact.

You might also be interested in these articles:

• When a key comes before a ring
• Prenups aren’t just for the rich and famous

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