Capital gains tax and divorce
Draft legislation has been published to introduce a new regime for capital gains tax (CGT) on divorce or separation.
In summer 2020, the Office of Tax Simplification (‘OTS’) was asked to review CGT by the then Chancellor, Rishi Sunak. The request came as a surprise to tax professionals who speculated that there were plans afoot to bring CGT and income tax rates closer together as a way of raising more revenue. In the event, the OTS did propose a greater alignment of rates, along with a reduction in the annual exemption from the current £12,300 to a de minimis figure of just £2,000-£4,000.
The Chancellor rejected both suggestions, but not before CGT receipts had been boosted by some investors taking what proved to be unnecessary pre-emptive action. However, Mr Sunak did accept a range of technical changes put forward by the OTS, one of the most important of which related to the interaction of CGT and divorce.
The current rules
The general rule is that transfers between spouses and civil partners are deemed to be on a no-loss, no-gain basis. The result is that that the receiving spouse/partner acquires the transferred asset with the base cost that applied to the transferring spouse/partner, so no gain or loss arises. The snag faced by separating or divorcing spouses/partners is that this rule only applies in a tax year during which the couple have lived together.
That means, for example, if you separate in January, then you have only until 5 April before CGT starts to be a consideration in any rearrangement of the ownership of assets. As the OTS noted in its report, ‘The average time between applying for and securing a divorce in England and Wales in 2020 was 53 weeks. Separating and starting the legal process of divorce are not the same thing.’ The OTS proposed that a more reasonable timeframe would be for no-loss, no-gain to apply for up to 2 tax years after the tax year of separation.
The draft new rules
Draft legislation published in July goes one better than the OTS proposal and gives couples up to the earlier of:
3 tax years after the tax year of separation; and
the date on which a court grants an order for divorce, the dissolution or annulment of a civil partnership, judicial separation, or separation in accordance with a separation order.
Any transfer arising as from a formal divorce agreement will also be treated as no-loss, no-gain, with no time limit applying.
The draft legislation covers 2 other CGT-linked areas where the OTS proposed reform:
A spouse/civil partner who retains an interest in the former joint home will have the option to claim Private Residence Relief when it is sold; and
Individuals who transfer their interest in the former home to their ex-spouse/partner and are entitled to receive a share of the proceeds on eventual sale, will be able to adopt the same tax treatment to those proceeds as applied when the original transfer occurred.
The legislation should become law from 6 April 2023 and will only apply to disposals from that date.
Action
The introduction of no-fault divorce in England & Wales from April 2022 has already seen an uptick in divorce applications. The draft legislation is a welcome simplification in this difficult area, but it is a pity its start date was not linked to the new divorce rules.
If you are considering or are in the process of divorce, CGT issues are set to largely disappear, but there are many other financial aspects which will continue to require professional advice, notably pensions. Contact us in confidence if you need more information.