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Family and divorce & UK trusts, tax and estate planning
What can we expect from the Chancellor’s budget and should potentially divorcing couples take heed?
Private Wealth Trainee, Jonathon Goldstone, considers some of the important implications Capital Gains Tax changes may have in divorce.
12 February 2021
The Covid pandemic has dealt a serious blow to the state of the nation’s finances. Predicting what the pandemic holds in store has proven a real problem for commentators and the Government alike, but it seems certain that eventually the Exchequer will need to come up with some way to address the mounting debt. While the Conservative Party rarely wants to be seen increasing taxes, desperate times call for desperate measures and the Chancellor Rishi Sunak has laid the ground for a shake-up in the capital gains tax (CGT) regime. There are exemptions and reliefs for CGT, but these are likely to be under review. Any changes could affect a wide variety of taxpayers, not least partners going through the process of divorce.
A review published in November 2020 by the Office of Tax Simplification (OTS), commissioned by the Chancellor, recommended increasing CGT rates to bring them closer into line with income tax. This could bring the highest rate of CGT to 45%, far above the current ceiling of 28% on residential property and 20% on other assets.
Notably, CGT is not subject to the “triple lock” promise of the last Conservative manifesto, unlike income tax, NICs and VAT. This makes CGT one of the few options for the Chancellor to raise taxes without going back on past promises.
Another option available to the Chancellor is to alter or remove some of the existing exemptions and reliefs that protect certain transfers from CGT liability.
Entrepreneurs Relief has already been a partial casualty and may be on its way out altogether. In March 2020 it was rebranded as Business Asset Disposal Relief (or BAD Relief) and capped at £1 million during a taxpayer’s lifetime. It is not a huge stretch to imagine this being cut further or removed altogether, and the PR optics for most of the public of removing BAD Relief seems something of an open goal for the government.
The OTS also suggested reducing the annual exempt amount from its current level of £12,300 to a de minimis value between £2,000 and £4,000. Currently a taxpayer can realise gains of up to £12,300 in a year before incurring a CGT liability. However, the OTS observes that this can distort behaviour, leading to people realising larger gains in annual chunks so as not to incur tax. Reducing the exempt amount to a lower figure would greatly reduce flexibility in this respect, making it much more difficult to realise larger gains in this manner in a reasonable timeframe.
But what does all of this have to do with divorcing partners? One of the other exemptions for CGT is for gifts between spouses and civil partners. There is no suggestion currently that this is under threat, but partners going through a divorce ought to think carefully about how they proceed to avoid an unexpected tax bill (and one that could well be higher if rates are increased in the anticipated March Budget).
The “transfer between spouses” exemption effectively continues to apply in the case of divorcing couples for transfers which occur during the year in which separation takes place. This is true whether or not the transfer happens before or after the partners separate or stop living together, so long as it is in the same tax year.
Once the next tax year begins, however, further transfers between partners are potentially subject to CGT, and the rates are likely to be higher after March than they are now. Often in a divorce case one partner will depart from the matrimonial home and transfer their interest in it to the other partner. Except for during the year of separation, this transfer will be considered a disposal for CGT purposes and a gain may be realised. Irrespective of any actual sums of money involved in this transfer, until the divorce is finalised by a decree absolute or dissolution the transfer will be deemed to take place at market value.#
That being said, the transferring partner may mitigate their CGT exposure. They can elect for the former matrimonial home to be treated as their primary residence from the date of their departure until either the date of the transfer or, if the other partner has also left the home, the date of this second departure, whichever is earlier. This allows the transferring partner to benefit from the “Private Residence” relief, meaning the transfer will not attract a CGT liability. This would however prevent them from applying the relief to a new home which they may have bought, so a cost/benefit analysis may be required to decide whether or not such an election is tax efficient.
Turning again to the annual exempt amount, at its current level it does allow for a degree of staged planning to minimise exposure to CGT, with assets being transferred between divorced partners over a number of years to avoid realising a gain above £12,300 in any given year. If the annual exempt amount falls significantly, this may no longer be a viable option – there are likely to be more pressing considerations in the divorce than simply minimising tax exposure!
All of this means that for divorcing partners with significant marital assets which are likely to be transferred between one another, the costs of leaving these transfers too late are only going to increase. Divorces can be fraught enough without these additional headaches. Receiving an unexpected and potentially avoidable tax bill is only going to add insult to injury.
This article was first published on IFA Magazine in February 2021.
12 February 2021
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