Legal
Divorce And CGT - Tax At A Taxing Time

Divorce can be painful for all kinds of reasons. An added source of difficulty in reaching settlements can be capital gains tax.
What happens in terms of capital gains tax upon divorce? The
UK government has been urged to hike CGT (this tax is likely to
go up in the US). Couples who have amassed wealth have to
confront the tax angle if they break up.
To discuss these issues are Jo Carr-West, partner and Lara
Barton, partner, at Hunters Law. The editors
of this news service are pleased to share these views and invite
responses. The usual editorial disclaimers apply. Email
tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com
When separating spouses are negotiating how to divide their
assets, they may overlook the tax consequences of the asset
transfers needed to achieve the proposed division. For wealthier
couples the tax implications can be significant, with aspects of
the capital gains tax system posing particular challenges. A new
report from the Office of Tax Simplification has made proposals
addressing two such issues.
The first relates to the CGT exemption benefitting married
couples which allows them to transfer assets to each other at “no
gain no loss,” i.e. without triggering a CGT charge at that time
(the base cost of the asset is inherited by the receiving spouse,
meaning that the full amount of CGT will be payable when they
sell or transfer the asset). The “no gain no loss” rule applies
during the marriage and until the end of the tax year of their
permanent separation. Permanent separation occurs when the
parties start living separately in circumstances that are likely
to be permanent, enter a deed of separation, or are separated
under a court order.
After the tax year of separation, transfers between separated
spouses take place at deemed market value, meaning that even if
no cash has changed hands, the transferor will be treated as
having sold or transferred the asset for its current market value
and will be assessed for tax on the gain. This would apply, for
example, where a shareholding or holiday home is transferred from
joint names into one party’s sole name.
By setting the timeframe for the end of the “no gain no loss”
exemption by reference to the tax year, the system arbitrarily
favours those who separate early in the tax year - spouses
separating in late March have only days to benefit from the ”no
gain no loss” rules, nowhere near long enough to agree and
implement a financial divorce settlement.
Even those separating earlier in the tax year may struggle with
the timeframe; most separating spouses do not start negotiating
their divorce settlement the moment they separate. Even once the
process has begun, the mutual financial disclosure, negotiations,
and settlement is likely to take many months, and approval of the
settlement by the court some further weeks. For those couples who
need a court decision to resolve their financial arrangements,
the process is most unlikely to be concluded within a year,
particularly given the delays in the court system.
The current rules therefore often add to a couple’s stress in
what is likely to be a very fraught time. One or both parties may
feel pressurised into making decisions outside the scope of an
overall agreement in order to benefit from the “no gain no loss”
rule, before they have had time to fully consider all the other
implications.
It is therefore welcome that the OTS recommends that:
"The government should extend the ‘no gain no loss’ window on
separation to the later of:
• the end of the tax year at least two years
after the separation event; and
• any reasonable time set for the transfer of
assets in accordance with a financial agreement approved by a
court or equivalent processes in Scotland." (1)
This would ensure that, where a settlement is approved by a court
(as is always recommended), and the transfers take place within
the agreed timeframe, no immediate charges to CGT should arise.
It is to be hoped that this proposal will be adopted.
The second proposal relevant to divorcing couples is of more
general application, but likely to be of particular significance
for separating spouses. In April 2020, HMRC drastically reduced
the period for reporting and paying CGT where tax is due
following the disposal of UK residential property by UK-resident
individuals, trustees or personal representatives. Prior to 6
April 2020, taxpayers were required to report such disposals and
pay any tax due by 31 January following the end of the tax year
in which the disposal took place, giving them between nine and
almost 22 months, depending on when the disposal took place. As
from 6 April 2020, the timeframe is now just thirty days from
completion.
This is likely to be particularly problematic for divorcing
spouses. Whilst the gain on the family home will often be covered
by Principal Private Residence relief, the transfer between them
of an investment property or holiday home is now (if outside the
tax year of separation) subject to an immediate charge to CGT. As
the property is not being sold, no liquidity is being released.
When the parties had many months to raise the necessary funds
this could often be managed; for many it is now considerably more
challenging.
Even beyond the liquidity issue, 30 days is very a tight
deadline, particularly when one considers the process required to
use the UK Property tax return system, which involves first
creating a Government Gateway user ID (if the taxpayer does not
already have one), and then setting up a UK property account,
before authorising an agent to deal with HMRC on the taxpayer’s
behalf (where applicable). Further, a considerable amount of
information is required to calculate the CGT and complete the
return, including: the base cost of the property; the cost of any
capital improvements; costs of acquisition and disposal; the
extent to which PPR applies to any part of the gain; details of
any capital losses or available Annual Exempt Amount to offset
against the gain; and an estimate of the taxpayer’s income for
the relevant tax year to ascertain the rate of CGT which is
likely to apply. Whilst information gathering can begin in
advance, this remains a lot of information to collate, and some
of it may not be readily available. For those managing the
implementation of a divorce settlement at the same time, this
creates additional pressure.
Given how ambitious the 30-day deadline is, it is perhaps
unsurprising that research has shown that one third of the tax
returns received between 6 April 2020 to 6 January 2021 took
longer than thirty days to arrive. (2) (However, for returns due
up until 30 June 2020, the reporting deadline was extended to 31
July 2020, making it likely that some of the so called ‘late’
returns would have been filed within the 30 days but for the
extension).
The OTS recommends that: “The government should consider
extending the reporting and payment deadline for the UK Property
tax return to 60 days, or mandate estate agents or conveyancers
to distribute HMRC provided information to clients about these
requirements.” (3) Whilst the wider dissemination of
information is important, it would not address the liquidity
issue faced by separating spouses; the proposed extension to 60
days may be of some - limited - assistance.
Overall, the proposals of the OTS outlined in this article would
assist divorcing couples. Whilst a 30-day extension to the CGT
deadline in residential property transactions may be of only
limited help, if the proposals to significantly extend the use of
the “no gain no loss” rule are adopted, CGT would, in any event,
rarely be payable on the transfer of a residential property
between separating spouses.
Footnotes:
1, Recommendation 7 in
Capital_Gains_Tax_stage_2_report_-_May_2021.pdf
(publishing.service.gov.uk)
2, HMRC data included within Annex D of Capital_Gains_Tax_stage_2_report_-_May_2021.pdf (publishing.service.gov.uk) [Accessed 14 June 2021]
3, Recommendation 3 in Capital_Gains_Tax_stage_2_report_-_May_2021.pdf (publishing.service.gov.uk)