UK Government issues draft legislation to lighten CGT burden for separating couples

Article 23 August 2022 Experience: Divorce and family lawyers
Tax

Many couples are surprised to discover that transfers of assets from one to the other on relationship breakdown can result in capital gains tax liabilities if transfers are not exempt or are made after the year of separation. But draft legislation which has just published suggests those rules are about to change. This is good news for those who have already separated (or who are considering it) and who need to work out how best to sort out their finances in the most tax efficient way. In this article, we explain what the current position is and how the proposed rule change will benefit clients separating couples once the new rules apply.

Married couples (1) can usually transfer assets (such as properties, shares or businesses) between themselves without any tax implications arising at the time of transfer (known as ‘no gain/no loss’ treatment). Specifically, if the first spouse gives or sells an asset to the second spouse, the second spouse will be deemed to acquire the asset at the first spouse’s base cost for Capital Gains Tax (CGT) purposes and will only have to pay CGT arising on increases in value over both spouses’ periods of ownership if that asset is later sold/gifted to a third party.

When couples separate, they may have to consider CGT for the first time. As things stand, there is only a short ‘grace period’ in which a couple who have separated continue to be treated as a married couple for CGT purposes. This grace period currently lasts for the remainder of the tax year in which a couple separates. (Note that ‘separation’ here has a specific meaning for tax purposes. Specialist advice should be taken to confirm how the rules apply to your circumstances. For example, a couple may not necessarily be separated for tax purposes just because they are living separately, and equally a couple who live together can still be separated.)

In many cases, the grace period is not long enough. It can take time for a couple to agree who should receive what following a divorce. Often they have other immediate concerns such as coming to terms with what has happened, and shielding their children from the fall out; and/or sometimes because the couple’s finances are complex, requiring equally complex disclosure, negotiations and specialist and bespoke solutions. To illustrate this: a couple who separates in the 2021/22 tax year would have until 5 April 2022 to rearrange their finances on a no gain/no loss basis, regardless of the date on which they separated. This means that a couple who separated on 5 May 2021 would have an 11 month grace period compared to a couple separating on 1 April 2022 who would only have 4 days.

To read more about the current situation , our colleagues have previously written about the unexpected “tax traps” for married couples or civil partners who separate some time before their financial affairs are settled.

However, there are about to be some welcome changes on this front. Now, following a set of recommendations issued by the Office of Tax Simplification, which the Government accepted last year, the Government has published draft legislation to amend the existing CGT rules to make it less stressful for separating couples to arrange their finances between them after they have made the decision to end their marriage or civil partnership.

The new rules, set to come into effect under the Finance Bill 2022-2023 and affecting asset transfers on or after 6 April 2023, target two aspects of the CGT rules which historically have resulted in millions of pounds in CGT being paid each year when separating couples have to rearrange their financial affairs (2):

  • The window of time in which couples can continue to make transfers between themselves on a ‘no gain/no loss’ basis as mentioned above
  • The ability for a non-occupying spouse to claim Private Residence Relief (PRR) when the former matrimonial home is sold at a later date (for example, where they have retained a share in the property but the other spouse has continued to live there)

No gain/no loss treatment

Under the new draft legislation, the no gain/no loss window is extended until the end of the third tax year after the year of separation. While still resulting in a disparity between couples who separate at the beginning or at the end of a tax year, the extended window should significantly ease the pressure on all couples. For example, a couple separating on 6 April 2023 would have a 4 year window lasting until 5 April 2027, and a couple separating on 5 April 2023 would have a 3 year window until 5 April 2026 to make any transfers.

In addition, transfers of assets made pursuant to a court order will also take place on a no gain/no loss basis without any time limit. This is significant because it is almost always advisable for a couple to formalise whatever they might have agreed and however they might have agreed it in a court order because this ensures that what was agreed can be enforced later down the line, and removes the possibility of unanticipated future claims.

Private Residence Relief and the family home

PRR is a generous relief that potentially applies to exempt from CGT the entire gain realised on the sale or transfer of an individual’s main residence. However, where an individual ceases to occupy the main residence before it is sold, this can result in PRR being applied only to a proportion of the gain.

Our colleagues’ previous article, already referred to above, discussed some of the traps that the PRR rules hold for separating couples. One trap concerns the fact that PRR can apply to the full period of an individual’s ownership even if the individual was not in occupation during the nine month period prior to the sale of the property, but it will not apply to any period of non-occupation beyond the nine months. For example, if a spouse leaves a jointly owned marital home in March 2021 and it is sold in June 2022, PRR will not be available to the departed spouse for the period between January and June 2022. (However, even under the existing rules the nine month period could be extended if the departed spouse transferred his/her interest to the spouse who remains living in the property).

Under the new draft legislation, some relief is offered to separating couples in this situation, as the nine month period can (if the non-occupying spouse elects) be extended for the entire period of non-occupation where the property is being sold to a third party.

The draft legislation also benefits spouses who, rather than retain an interest in the former matrimonial home, are entitled to a share of the proceeds when it is sold.. In this situation, the spouse who left the property can claim PRR on his/her share of the profit when it is eventually sold, as if the sale took place when he/she originally transferred his/her interest to the spouse who remained in occupation.

Transitioning to the new rules

Assuming the draft legislation actually comes into effect next year as anticipated, the proposals are good news for couples who separated on or after 6 April 2022 or who will separate in the future. These couples are now under less time pressure to finalise a financial deal and CGT will be less of a constraint on their available options.

Those who separated before 6 April 2022 and are yet to finalise a financial deal can also benefit to the extent they are willing to defer the transfer of assets until after 6 April 2023. However, there may be non-tax reasons which speak against this and specialist advice is always recommended.

Couples who have already agreed a financial deal will, broadly speaking, only benefit to the extent any transfers happen after 6 April 2023 and whilst some capital orders (ie transfers of assets) on divorce can be varied in certain limited circumstances, it is highly unlikely that the proposed tax change will be a sufficient reason to ask the court for a variation.

(1) – We refer to married couples, spouses and husbands and wives throughout this article for simplicity, but what we say applies equally to those in a civil partnership

(2) – HMRC identified at least £8m of CGT that was incurred by divorcing couples in 2018/19 as a result of the current rules: p.60 of the OTS report

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