Ellie Foster is a Legal Director in the Family team at Raworths. In this article Ellie looks at the draft legislation recently published by the government relating to proposed changes to the rules applying to the capital gains tax (CGT) treatment of assets on divorce.
These proposals have been welcomed by family lawyers as the benefits to separating couples may be significant. Couples would have significantly more breathing space to deal with all the personal and financial implications of their separation at what is already a difficult time, without pressing tax deadlines.
At the moment, there are two key issues facing separating spouses where CGT is concerned:
1. Assets can be transferred between spouses at no immediate charge to CGT in the tax year of separation. This is known as the ‘no gain, no loss’ rule. It does not mean that CGT disappears and is avoided entirely; the liability for CGT is instead deferred and paid by the recipient when they eventually dispose of the asset.
To give an example, if Annie and Ben separated in March 2022 (in the 2021-2022 tax year) and transferred assets between them in September 2022 (being the 2022-2023 tax year) then CGT may be payable immediately on an increase in value of the assets.
If Annie and Ben separate in the current 2022-2023 tax year, then they will have until 5 April 2023 to transfer assets between them to take advantage of this rule. Obviously, if they had separated early in the tax year, say in May 2022, then they would have time to discuss and agree a settlement and transfer assets. However, if they were to separate in, say, March 2023, then there could be a rush to try and transfer assets between them before the 5 April deadline to avoid the immediate payment of CGT – this may or may not be feasible. If not, then Annie and/or Ben could find themselves with a significant tax bill to pay immediately, which could create cash-flow problems.
2. Principal Private Residence relief (PPR relief) can apply to exempt a chargeable gain on a main residence on sale or transfer. However, if one spouse leaves the family home this risks the exemption not applying in full for them. PPR relief is currently only available in full on a transfer of a main residence by a non-occupying spouse to the occupying spouse, not a sale to a third party where the non-occupying spouse has lived away from the property for more than 9 months. This potential tax liability is arguably unfair, particularly if there are very valid reasons for the separation.
So, if Annie and Ben had separated in May 2022, with Ben moving out of a jointly owned family home into a rented property, CGT may start to creep into the equation for Ben from February 2023 on a subsequent sale of the family home.
The draft legislation, which, if introduced, may apply to sales/transfers from 6 April 2023, includes:
Extending the period for which the ‘no gain, no loss’ rule can be used to up to 3 tax years following the tax year of separation.
So, if Annie and Ben separate in the 2022-2023 tax year, this would allow them up to 5 April 2026 to transfer assets between them at no immediate charge to CGT – potentially helping with cash flow.
Extending the ‘no gain, no loss’ period indefinitely for transfers pursuant to a formal divorce agreement, for example a consent order in financial remedy proceedings.
If Annie and Ben decide to divorce, then they could take advantage of this.
Extending the PPR relief rules, with certain conditions, to allow a non-occupying spouse to claim full PPR relief on a sale to a third party (or a deferred sale agreement) as well as a transfer to the occupying spouse.
So, this may allow Ben to claim full PPR relief and not risk a tax bill, even if he moved out of the family home more than 9 months before its sale.
It remains vital that divorcing couples fully understand the tax implications of a separation and/or divorce. The proposed rule changes would provide much needed time and flexibility, but it is important to remember that in many cases the CGT is deferred, not avoided, so expert tax advice is still needed to understand whether CGT applies to any asset, any relevant tax reliefs and the timeframe for payment of any tax so this can all be factored into a fair settlement.
For those couples who are thinking about a separation, or who may be close to reaching a financial settlement on a divorce, it would be sensible to seek swift tax advice to understand any potential tax exposure under both the current and proposed tax rules and whether it could be to their mutual advantage to delay a separation, court order or asset disposal in anticipation of the changes coming into force.