The break-down of CGT on divorce and separation
The Office of Tax Simplification (OTS) issued a second report on the 20 May 2021, titled ‘Capital Gains Tax Review; Simplifying practical, technical and administration issues’, in which they take the view that the current treatment of capital gains on separation and divorce is totally unsatisfactory and needs to change. In his blog, Neil MacGillivray, Head of Technical Support at James Hay, contemplates if capital gains tax on separation and divorce is set to become a thing of the past.
There were over 91,000 divorces in 2018, and for tax year 2018/19 at least £8 million was paid in capital gains tax (CGT) by just under 300 taxpayers who stated divorce or separation as the reason for the gain in their tax returns. The true figures will be much higher than reported as there’s no requirement for taxpayers to give the reason for transferring or disposing of assets. What seems apparent is the unforeseen cost, in perhaps an already expensive situation, of an average CGT bill of around £27,000.
Married couples and civil partners have the advantage of being able to transfer assets between themselves without creating a liability to CGT. Such transfers are treated as being carried out on a ‘no gain no loss’ basis. What this means, in simple terms, is the recipient is deemed to have received the asset at the donor’s acquisition cost, including any enhancement expenditure, plus any indexation allowance available up to 5 April 2008. If one transfers a buy to let property, currently valued at £175,000, to the other, which cost them £75,000 in 2010 and 2 years later they spent £25,000 adding an extension, the recipient is treated as acquiring the property at a base cost of £100,000.
To benefit from the ‘no gain no loss’ provisions the couple must be ‘living together’ at some point in the tax year. HMRC will treat spouses or civil partners as ‘living together’ unless they are separated under a Court Order, or deed of separation, or separated in circumstances in which the separation is likely to be permanent. For transfers made in the tax years after separation they are treated as a disposal at market value and a chargeable gain may arise.
The quickest a consenting couple can get divorced is between 4 and 6 months. However, the average time in England and Wales between applying for, and securing a divorce, in 2020 was just over a year. Where there are ongoing disputes it can be far longer. The ability therefore, even if separation took place at the beginning of a tax year, of starting legal proceedings, agreeing how assets should be split and physically transferring them by the end of the tax year is difficult, if not impossible, to achieve.
For many, the most valuable asset can be their home. CGT is not usually an issue as Private Residence Relief (PRR) applies. On separation, however, when one party moves out then there may be a chargeable gain if the period between moving out and the transfer or sale of the property is longer than the final 9 month permitted exemption period.
The charge can be mitigated, in certain cases, by an election allowing the former home to be treated as the main residence of the transferring individual until the earlier of the date of transfer, or the date on which the property ceases to be the only or main residence of the individual to whom the property is transferred. It should be noted that if the departing individual acquires another property, they will not obtain PRR on their new property for the period that the other property is still deemed to be their principal residence.
The OTS recommends that the government should look at extending the ‘no gain no loss’ window and PRR to the later of:
• the end of the tax year at least two years after the separation event, or
• any reasonable time in accordance with a financial agreement approved by a court. (A different solution would need to be found for Scotland as the courts are not automatically involved in the divorce process there.)
There is no doubt that such an extension would give the parties some additional breathing space to sort out their financial arrangements without a tax penalty and, additionally, remove a layer of complexity. That said, the OTS has produced a series of reviews on National Insurance, Inheritance Tax and CGT in recent times without the Government showing much enthusiasm to take up their recommendations, so don’t hold your breath.
In the meantime, what is clear is tax advice is important when married couples and civil partners separate. There are steps that can be taken, such as transferring assets over several tax years to maximise the annual exempt amount as well as transferring assets that have little gain. Anything that can help reduce the cost for those impacted has to be time well spent.
This blog first appeared on Professional Adviser