Splitting up: a taxing time

Family breakdowns can be difficult experiences for the parties concerned, and for good reason. The disentanglement of a life shared, sometimes over many years, is not an easy business. The main concerns for separating couples rarely involve taxation but, unfortunately, it still needs to be considered. In light of relatively recent changes in this sphere, it is always sensible to take stock of how the current rules actually operate.

1. Which tax means the most?

There are a number of taxes that warrant consideration in the context of a couple who are separating. Of particular relevance, not least on account of recent changes, is capital gains tax. The CGT treatment of disposals – remembering that “disposal” covers a great deal more than a sale – between married couples/civil partners is fairly well established and should be familiar to most practitioners. When someone transfers an asset (or part of it) to another, and both parties are (i) either married to each other or are civil partners, and (ii) live together, the disposal will not create a chargeable gain – the transaction is deemed to take place at “nil gain/nil loss”.

The situation was, until recently, broadly the same for couples who were separating or divorcing; the nil gain/nil loss treatment remained, but only until the end of the tax year in which the divorce/separation took place. This presented a potential issue in circumstances where the termination of a relationship was finalised close to the end of the tax year, creating an urgency to have relevant transfers completed before they would create a tax liability.

The Finance (No 2) Act 2023 has changed the rules somewhat, in that it relaxed the CGT rules on divorce, dissolution and separation. From 6 April 2023, where a couple is in the process of separation or divorcing, the nil gain/nil loss treatment will be extended for a period of time, depending on the stage that the couple are at in ending their relationship:

• for up to three years after the year when the couple stop living together as spouses/civil partners; and
• for an unlimited period where the transfer occurs as part of a formal divorce agreement.

The extension of what is generally regarded as favourable CGT treatment is, on the whole, welcome – it affords couples (and their advisers) more time to organise their affairs appropriately. That said, in difficult separations, sometimes being afforded more time (particularly where there are several assets) can be more of a curse than a blessing. Warring parties may see little reason to agree quickly on relevant values of properties, lengthening an already trying experience for all concerned.

2. Is it all good news on CGT?

On first principles, yes.

One of the main assets that needs to be dealt with in the context of family breakdown is the family home. Most practitioners will be aware of the valuable exemption from CGT that is private residence relief (“PRR”). For CGT purposes, where a couple sell their main home there will generally not be any CGT by virtue of PRR. However, the default position is that PRR is only available to cover actual periods of occupation of the main home. So, if a couple ends their relationship and one party moves into rented accommodation, the period that they are absent from the family home, subject to a few exceptions, could have CGT consequences in that PRR may not be available for that period.

The Finance Act 2023 did change the position somewhat. Where one party has moved out of the family home which is ultimately to be sold, the absent party can, subject to certain conditions, elect for their period of absence to be treated as a period of occupation. This effectively extends the period that PRR can be available to claim on the former main residence.

However, it should be noted that a person can only have one main residence at any one time. Therefore, if the leaving party purchases a new roof over their head but claims PRR on the former main residence, they cannot claim PRR on their new home until the former home has been sold. This, of course, could have adverse CGT consequences when the replacement home is sold, as the allowable PRR may not sufficiently cover the entire gain on sale. There are also property taxes to consider (see question 3).

The Finance Act 2023 went further still in that it introduced a rule (contained in s 225BA, Taxation of Capital Gains Act 1992) that where an individual transfers their interest in the family home to their soon-to-be “ex” in connection with divorce, dissolution or separation in return for a sum on disposal at a later date, that sum will be treated as if it had arisen at the time of the initial transfer. It is worthy of note that this does envisage the ultimate sale of the property to a third party and, presumably, on the open market for market value.

Caution is advised, though. It is worth remembering that PRR can only ever be attributed to one property at a time. If someone moves out of the former family home and buys another, they will need to consider which one should benefit from PRR. PRR is an incredibly valuable relief from CGT and does need to be used carefully to avoid it being wasted. Every situation will need to be treated differently and considered carefully.

3. What about property taxes?

As advisers will appreciate, where one tax is an issue, there will likely be others. This is particularly so in the context of the family home (and interests in land/buildings more generally) where couples part ways. Currently, where there is a transfer between a couple in connection with divorce/dissolution of a civil partnership under a court order, or under relevant family law legislation, there is scope for the transfer to be exempt from land and buildings transaction tax, under sched 1 to the Land and Buildings Transaction Tax (Scotland) Act 2013.

However, the story does not end there. As mentioned previously, for an individual, only one property at any one time can be the main residence (and protected from CGT by PRR). Therefore if the leaving party decides to buy another home to live in while the separation/divorce negotiations continue, the additional dwelling supplement (“ADS”) will be applied, as the purchaser already owns a property and the new house purchase will be considered a second home purchase. In Scotland, the rate of ADS is currently 6% of the total purchase price. By comparison, in England & Wales, the purchase of a second home will be subject to a 3% increase on the basic rates of stamp duty land tax. It may be possible to reclaim any ADS payable when the previous main residence is sold, but this depends on the timescales for disposing of the previous main residence.

As was mentioned earlier, tax is rarely first and foremost in the minds of couples who are separating. It is likely to be an unwelcome addition to the bundle of issues that need to be sorted out by couples who have, perhaps understandably, far larger issues to deal with. That said, it is an area that can result in significant liabilities and does merit careful attention to ensure that appropriate planning can be carried out with a view to avoiding unnecessary costs.