Waiting for the new divorce laws – could there be tax consequences?

Our colleagues James Riby and Charlotte Posnansky wrote recently about the changes to divorce laws and the advent of “no-fault divorce” on 6 April 2022 – see their article here.

We are already finding that some clients who would otherwise be starting divorce proceedings now are deciding to wait until the new law is in force so that they can avoid having to blame their spouse for the breakdown of the marriage by either citing their adultery or complaining that their spouse has behaved in such a way that they cannot reasonably be expected to continue to live with them.

There are practical benefits to waiting until 6 April before starting divorce proceedings. The new law is intended to reduce animosity and to help couples to focus on resolving the arrangements for children and finances amicably and by agreement. However, could there be unintended financial consequences for couples splitting up and waiting until the new law is in force to sort everything out?

Assets can be transferred between spouses who are “living together” in a tax year on a no gain/no loss basis – this means that no Capital Gains Tax (CGT) liability is triggered on such a transfer. Any gain in value since the asset was originally acquired is effectively passed to the spouse receiving or retaining the asset.  If and when they dispose of the asset, the full gain will be chargeable but they are able to avoid an immediate CGT liability on receipt of the asset from their spouse.

The no gain/no loss rule applies between spouses if they separate in the tax year even though they may not be living together at the time of the transfer.  After the tax year of separation, any transfer of assets between spouses may trigger a CGT bill in that tax year.

This raises the question as to when a couple is treated as living together. Couples are treated as living together unless separated under a court order, a formal Deed of Separation or “in such circumstances that the separation is likely to be permanent”.

If potentially chargeable assets are likely to be transferred from one spouse to the other or from joint names into one person’s sole name, careful thought should be given to this and to whether, if the couple are likely to be treated as separated for CGT purposes during this tax year, any transfers ought to be made before the end of the 2021/2022 tax year.

A CGT liability may also be avoided where the asset being transferred is the couple’s family home, although this does depend on a number of circumstances.

For many couples considering ending their marriage or civil partnership, especially those wishing to await the new “no-fault divorce” laws coming into force on 6 April, it may be sensible to put off a separation until the new tax year, if the circumstances permit this – doing so would allow them a much longer period of tax-neutral transfers of assets between them as they would then have until 5 April 2023 to resolve the arrangements and complete any transfers.  In some cases, parties agree to a transfer of a potentially chargeable asset before a whole settlement has been agreed for tax planning purposes.

In May 2021, the Office of Tax Simplification (OTS) published a report recommending that the government extend the “no gain/no loss” window to the end of the tax year at least two years after separation, or any reasonable time set for the transfer of assets in accordance with a financial agreement approved by a court.  The evidence they had gathered was that the current length of time given to separating couples to deal with their assets before a CGT charge may arise is inadequate and the OTS commented that “this change would give people the time they need during what can already be very difficult circumstances”. On 30 November 2021, the government confirmed that it accepted this recommendation and would consult on the detail over the course of the next year. 

The CGT rules during and following the tax year of separation are complex and depend on all the circumstances. The contents of this article are intended to provide an overview of some of the issues that may arise and should not be relied upon as advice. Advice should be sought swiftly on your specific circumstances if you believe that any of the issues referred to in this article, either during or following the tax year of separation, are relevant to you.